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What Are Stable Value Funds?

Carolyn writes in to ask,

“I recently started a new job and am looking for some help with the 401k. The plan doesn’t offer any bond funds with expense ratios below 1%. The plan does offer a stable value fund, but I’m not really clear on what that is, and there’s no ticker symbol for me to look up the fund online. Is a stable value fund a good replacement for a bond fund when you have no other low-cost choice?”

In short, a stable value fund is a bond fund that has an additional level of protection via insurance contracts that guarantee the value of the fund against fluctuations — whereas normal bond funds fluctuate in value every day due to changes in the value of the underlying bonds.

Risk and Expected Return

Because stable value funds have a double layer of protection (high-quality bonds, plus insurance protection) they’re definitely at the low-risk end of the investment spectrum.

Their risk level is somewhat higher than that of a savings or money market account (because insurance companies don’t quite offer the same degree of protection that you get with FDIC insurance) and somewhat lower than that of a typical intermediate-term bond fund (one without an insurance “wrapper”).

And as you might expect, stable value funds typically offer higher returns than FDIC-insured accounts (because they’re investing in investments that carry some degree of risk) and lower returns than a typical intermediate-term bond fund (because of the costs of the insurance protection).

Speaking of Costs…

Naturally, the fee that the insurance company charges reduces the fund’s return. With regard to asset allocation decisions, this fee is relevant for two reasons.

First, if the fee is particularly high, it may mean that the stable value fund isn’t actually any lower-cost than the other bond funds available in the plan — in which case you may want to use one of the other bond funds instead. (Or, even better, do your best to satisfy your bond allocation using low-cost bond funds in an IRA where you have your choice of investment options.)

Second, if you do decide to use the stable value fund for your bond allocation, it’s worth recognizing that it has lower risk and lower expected return than most bond funds. As a result, you may want to adjust your overall stock allocation upward slightly relative to what it would be if you were using a typical bond fund for your bond allocation.

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Comments

  1. That sounds interesting. I’ve not seen such funds before in the UK or Sweden.

    But apart from the cost of the insurance there is another problem: a lot of people buy bonds because they want their value to fluctuate to compensate for other parts of their portfolio. The idea is that long-dated bonds will rise in value when interest rates fall e.g. in a recession, when stocks will be expected to perform poorly. If you’re investing for the long term in a stable value fund you will be paying an insurance company to take this compensation away!

  2. I use the Stable Value fund in my 401k. It has an ER of .12 which isn’t too shabby. According to Quicken, my Avg Annual Return YTD is 2.6%. I use this fund (and Vanguard’s Short Term Bond Index in one IRA) to shorten the duration of our fixed income assets.

  3. I’ve used stable value funds somewhat as a substitute for a TIPS fund. The returns are far better than money market (in recent years), and they still shelter against rising interest rates.

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