Stabilize your retirement
You're really fed up with the abysmal returns on money
market funds and certificates of deposit. Now the stock market has
staged a mini rally that looks as though it might have some legs
and you're tempted to dump the fixed-income investments and rebuild
that battered retirement portfolio with hot stocks and mutual funds.
And maybe some sector investing -- telecom is due for a turnaround...
Whoa! A portion of the portfolio should stay with the slow growing
fixed income that was woefully underrepresented in your past life.
Better than you thought
Fixed income doesn't have to mean rock bottom returns. Stable value
investments can give you the return of a bond fund with very little
risk of losing principal. Stable value funds had an average annual
return of 5.84 percent in 2002, and should come in around 5 percent
in 2003, according to Gina Mitchell, president of the Washington,
D.C.-based Stable Value Investment Association.
That makes stable value a better deal than short-term
bond funds and money market funds.
According to Lipper, the mutual fund research company,
the one-year average annual yield for short-term bond funds is 5.26
percent, and 0.73 percent for money market funds. A one-year CD
is paying an average annual yield of 1.05 percent.
The five-year average total return for stable value
is 6.35 percent vs. 5.34 percent for short-term bonds, 3.44 percent
for money market funds and 3.69 percent for CDs.
"The return, the capital preservation and the
predictable income are very important. Stable value blunts the volatility
of the stock market," says Mitchell. "The stock and bond
markets can be a roller coaster ride; stable value is your seat
Unlike bond funds where the net asset value (NAV)
falls when yields rise, stable value funds seek to keep the NAV,
which is the share price, at $10, just as money market funds strive
to keep the NAV at $1.
Most of the funds invest primarily in short and intermediate-term
high quality government and corporate bonds, guaranteed investment
contracts and asset-backed securities. An insurance company or a
bank guarantees the $10 NAV.
Safe -- but with risks
While the investments are considered very safe, and no investor
has lost principal or interest, there is some risk. These are not
government insured like CDs or money market accounts. There can
be, and there have been, defaults, and even though you'll likely
get back all your money, it may take time.
"These are baby steps away from the bank,"
says Jason Flurry, a certified financial planner and president of
Legacy Partners Financial Group, Woodstock, Ga.
"There's risk associated with stepping away from
CDs, but there is also risk for earning 1, 2 or 3 percent for an
extended period of time. Given the short duration and the typical
high quality of the investment grade, there's probably very little
chance that anything could come back to bite you. But who would
have thought Enron and WorldCom corporate bonds could default?"
Stable value investments are available only through
IRAs, employer-sponsored retirement plans such as 401(k)s and some
529 college savings plans. The bulk of stable value investments,
$321 billion, are held in 401(k)s. IRA stable value mutual funds,
which were introduced in late 1997, come in a distant second with
$5 billion, and the 24 states that offer stable value in their 529
plans hold a total of $1.24 billion in stable value investments.
Overall, stable value assets have increased by more
than 30 percent since 2000, no doubt due in large part to investors
seeking safety from the bear market along with a decent return.
Issue of liquidity
While stable value can be an excellent investment and fill an important
niche in your portfolio, there are drawbacks.
Owning stable value in a 401(k) is a better deal than
owning a stable value mutual fund in an IRA. Fees are lower and
there is more liquidity.
The average expense ratio for stable value investments
in a 401(k) is 0.41 percent, while many of the mutual funds charge
1 percent or close to it. As a comparison, the average expense ratio
for money market funds, according to iMoneyNet, is 0.60 percent,
while Lipper pegs the average expense ratio for short- to intermediate-term
investment grade corporate bond funds at 0.86 percent.
Stable value isn't as liquid as a money market fund.
You can cash out anytime, but there are restrictions in 401(K) plans
and penalties in IRAs.
You can't move your money in and out of stable value
in a 401(k). You'd have to move your money to a "non-competing"
fund or investment for 90 days before coming back to the stable
"Stable value lags interest rate changes,"
explains Laura Dagan, portfolio manager at Dwight Asset Management,
a company that manages stable value investments for institutional
"As the Fed starts raising rates money market
funds will go up immediately, stable value will not. If money market
funds got higher than stable value, everyone would move money from
stable value to the money markets. That's why in a 401(k) you can't
transfer directly from stable value to a competing fund. You'd have
to go to an equity fund or one with volatility for 90 days. It takes
out the arbitrage opportunity."
Most of the stable value mutual funds that are available
for IRAs charge a redemption fee of 1 or 2 percent for cashing out
in less than one or two years. A few reserve the right to charge
a 2 percent fee if you withdraw your money during a rising interest
Lack of regulation checked by
Another consideration is that there are no rules regarding asset
quality in stable value mutual funds as there are in money market
funds. Most funds stick with high quality securities, but some could
lean toward junk to beef up their yield if they wanted.
"There are no regulations but there's a market
force that keeps it from being extreme," says Gina Mitchell.
"They can't get the (insurance) wrap. It would be too costly
and would eliminate any value of the stable value fund."
The Securities and Exchange Commission is looking
into how stable value mutual funds maintain the NAV.
"There isn't clear guidance in the mutual fund
world and the SEC wants to get comfortable with this unique vehicle.
They want to write rules, so they're looking at how the stable value
is achieved from an accounting rules perspective and from their
regulatory perspective," Mitchell says.
"If the SEC had a concern or had found a problem,
I think we would have heard from them by now. But it's like being
audited by the IRS; it can cause anxiety. We're waiting to hear
what they have to say."
There reportedly is no question regarding stable value
investments offered through employer-sponsored retirement plans.
An SEC representative declined to comment on the issue.
Shopping for funds
When considering a stable value mutual fund, be sure to look at
the securities, their duration and maturities.
"Look for investment-grade only and short-term
duration, one-and-a-half, two-and-a-half years," says Jason
Some funds may buy securities that mature in five
years or longer because they want to pick up a premium with the
longer maturities. But, ideally, the average duration -- the average
of when all the securities in the portfolio mature -- should be much
shorter. This helps ensure the fund won't be stuck with longer-term
low rates when rates start to rise.
Stable value investments aren't necessarily just for
people who are closing in on retirement and want to control risk,
according to Peter Bowles of FCM Capital Management, in Woodbury,
"If you're 25, in theory, you won't retire for
40 years. But things can happen. The 401(k) is accessible for a
down payment on a first house and it can also be used for college
tuition. So, maybe your investment horizon is five years.
"The individual has to make a commitment. Is
this a retirement program that I am not going to touch until retirement
or a savings program that I may touch for college or a down payment
on a house? If the answer is the second, then stable value makes
sense at a much younger age."
The big six
If you're interested in a stable value investment, check with the
manager of your 401(k), or consider one of the stable value mutual
funds that can be held in an IRA. There are only eight mutual funds,
and two require a minimum investment of more than $500,000. Here
are the six that have requirements more suitable to individual investors:
- Scudder Preservation Plus Income Fund DBPIX
- Security Capital Preservation Fund SIPAX
- Vantagepoint Income Preservation Fund VPIPX
- Gartmore Morley Capital Accumulation Fund NMIRX
- PBHG IRA Capital Preservation Fund PBCPX
- Principal Investors Capital Preservation
Fund -- can only be purchased directly from the company (1-800-247-4123)
or at their Web