The role of stable value funds in a diversified 401(k) portfolio

July 12, 2023

woman evaluating stable value funds

When plan sponsors and financial professionals choose plan investment options, their aim is to provide all participants with choices that are appropriate for their retirement savings objectives, while acknowledging that different people’s objectives are likely to vary widely.

Together, the sponsor and financial professional evaluate funds’ potential for volatility, returns and diversification. They keep in mind a range of investing horizons and levels of risk tolerance.

That’s why it’s not surprising that stable value funds are a popular investment choice among 401(k) plan participants — and an important tool many investors use to achieve a conservative, fixed return while preserving their capital.

In periods of rising interest rates and high rates of inflation, a stable value fund’s guarantees may make it an attractive investment option for participants looking for stability — so it’s worth taking some time to investigate whether they should play a role in your plan's capital preservation lineup. 

Before making your decision, be sure you understand how stable investment funds work, their potential strengths and weaknesses, and how they can be part of a diversified retirement portfolio.

What is a stable value fund?

Typically, stable value funds are managed “funds of funds” that include an insurance contract component that guarantees book value (that is, principal plus accrued interest) to participants when they take distributions or make transfers to other investments. 

The fund itself is often a complex combination of highly rated corporate debt and highly rated securities sponsored by banks or trust companies, combined with “wrap contracts,” or “wrappers,” issued by insurance companies and designed to help protect against falling yields and/or capital losses. Because the fund manager can adjust the duration of the fund’s bond holdings, a stable value fund can help investors address inflation risk.

While stable value funds are often complex, their objective is straightforward: provide a consistent return and preserve the investor’s principal.

Pros and cons of stable value funds

It’s well understood that every investment involves certain risks and trade-offs, and stable value funds are no exception. Stable value funds are generally designed as long-term investment instruments with a major focus on capital preservation, so it’s fair to anticipate a lower-risk, lower-return scenario. 

Some of the reasons plan participants find stable value funds attractive include:

  • Relatively low risk: Highly rated investments, along with an insurance contract component, help guarantee against a loss of principal, unlike other investments that fluctuate in value.
  • Competitive yields: Other low-risk investments like bank savings accounts and money market funds often post lower yields, so a stable value fund may help counter the effects of inflation.
  • Liquidity: Stable value funds are often designed to provide investors with retirement income or liquidity for loans or hardship withdrawals.

Stable value funds may place restrictions on liquidity, however, to protect plan investors and fund providers from losing money. For example, there can be significant waiting periods for withdrawals for other reasons, such as transfers to competing funds or employer-initiated plan changes. 

Plan participants can experience these restrictions as limits on how often and/or how quickly they can move their money. Plan sponsors need to understand and anticipate any issues that may arise if they wish to change plan providers or discontinue offering the fund as an investment option. Along with limited liquidity, other considerations include:

  • Lower potential reward: This is typically the flip side of the low-risk coin. Investments like stocks and bonds often have greater upside potential alongside their risk of loss. Investors have to consider whether they can meet their retirement goals at lower rates of growth.
  • Limited investment options: Underlying investments are typically chosen by the fund manager and/or the insurance provider, and can be a complex combination of many different securities.
  • Market value adjustments (MVAs): Employer-initiated events like plan termination or change in investment options can cause large withdrawals from the fund and trigger an MVA. AN MVA is an adjustment meant to reflect the difference between book value and market value of the fund, and may result in an increase or decrease in the amount received at withdrawal.

Choosing a stable value fund with care and diligence

As with all plan investment options, it’s up to the plan sponsor to seek appropriate guidance to ensure you understand how each investment choice works, its features, underlying assets, and other factors. Before you decide, ask about the details, including:

  • Contract and product features
  • Past performance
  • Underlying investments
  • Wrap provider rankings and creditworthiness
  • Wrap capacity and limitations
  • Exceptions and termination provisions
  • Withdrawal restrictions
  • Fee transparency
  • Fund portability

It’s important to commit to ongoing monitoring of the stable value fund you select. This includes keeping a watchful eye on creditworthiness and financial strength of the insurance company or companies issuing the wrappers, as well as regular reviews of market value versus book value.

Where to learn more about stable value funds

As a plan fiduciary, you need reliable information about your plan’s investment choices, and that starts with your sources. Reach out to a plan provider and ask about how they help educate and inform plan sponsors on the details of investment options. They should be ready and willing to provide the resources you need without hesitation.