Some 54 million American workers are active 401(k) participants. Recent estimates from the Investment Company Institute show that 401(k) plans held $5 trillion in assets at the end of March, 2017, representing nearly one-fifth of the $26.1 trillion in U.S. retirement assets, which include employer-sponsored retirement plans, annuities and individual retirement accounts (IRAs). Mutual funds make up the lion’s share of 401(k) assets: Nearly two-thirds (64 percent) of 401(k) assets are held in mutual funds. Still, most 401(k)s offer participants a variety of investment options, which may include company stock, individual stocks and bonds, guaranteed investment contracts (GICs) and various other investment products—including stable value funds.

A stack of coins for stable value funds.

Small, Steady Returns

Stable value funds are a blend of insurance and bonds that act as cash equivalents in 401(k) plans (they are typically available only to 401(k) plan participants of employers who offer them). They provide steady—albeit small—returns, plus principal protection.

While stable value funds resemble their money-market fund cousins, they generally offer significantly higher yields: According to Callan Associates, an investment manager, the median rate on stable value funds in the first quarter of 2016 was 1.93 percent. Meanwhile, the average yield for money-market funds was a notably lower 0.023 percent.

Funding Vehicles

At one point stable value funds invested almost entirely in GICs, which are agreements between insurance companies and 401(k) plan providers that promise a specified rate of return. GICs, however, are no longer the funding vehicle of choice for stable value funds, partly because a number of insurance carriers—who invested heavily in junk bonds in the 1980s—suffered large losses and defaulted on their GIC agreements. Another reason is that some unfortunate 401(k) plan participants found out their GICs would become invalid if the company declared bankruptcy, as was the case at Lehman Brothers.

Today stable value funds invest mostly in short- to medium-term government and corporate bonds, which means they can pay higher rates than money market funds, whose investments typically have maturities of 90 days or less. To mitigate any interest-rate risk caused by these longer maturities, stable value funds purchase insurance guarantees to offset any loss of principal.

And Now the Bad News

Stable value funds can be a smart investment: After all, they offer better returns than money market funds and are considered a conservative, low-risk investment. There are, however, some drawbacks and limitations that investors should be aware of before making any investment decisions.

One drawback is that stable value funds charge annual fees to cover the cost of the insurance wrappers (the principal protection provided by the insurance carrier). These fees can be as high as 1 percent per year, which can significantly erode any potential earnings.

Another important fact to remember: While stable value funds are, as their name implies, relatively stable instruments, they are not guaranteed. As such, they shouldn’t be grouped with certificates of deposit, fixed annuities and other products that offer a total guarantee of principal.

Something else to consider: If you have money in a stable value fund, you may not be able to move it directly into another similar investment, such as a bond fund or money market fund. In many cases you must first move your money into another type of investment—a stock sector fund, for example—for 90 days before moving your funds back into a cash alternative.

Keep in mind, too, that while stable value funds offer income with little risk and are ideal for investors with short-term horizons, they are not long-term growth investments. As low-risk instruments, they can’t provide the same type of returns as stock funds. As such, most financial advisors recommend allocating no more than 15 to 20 percent of your assets to stable value funds.

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