Stable value funds are typically low-risk investments and are popular investment options available in many 403(b) plans. Until recently, stable value funds were only available in some employer-sponsored retirement plans such as 401(k) and 403(b) plans, as well as in 529 college savings plans. However, it is now possible to purchase a stable value fund for an individual retirement account.
The investment objective of stable value funds is to provide capital preservation (protect the principal amount invested) and offer steady, predictable returns.
These funds typically invest in a high-quality fixed-income portfolio, often in guaranteed investment contracts (GICs). GICs are contracts with insurance companies.
What Is a GIC or Stable Value Fund?
A GIC or stable value fund is a fixed-income investment. It pays a fixed rate for a specified term, typically one to five years. GICs are purchased from an insurance company and may be offered individually or with other GICs in a GIC fund or stable value fund.
One reason behind the popularity of GICs may be a misunderstanding. It would be easy to assume that GICs eliminate the risk of loss of principal … after all, isn’t that what “guaranteed” means? The answer, in this case, is no. The guarantee applies only to the rate of interest that the issuer promises to pay. If the GIC issuer fails, the principal is at risk. Rating services, such as A.M. Best, rate the financial stability of insurance companies. With a high rating, there’s little likelihood that the company will fail. However, as we've learned from the volatility in the markets, even companies with high ratings, such as Lehman Brothers, can fail if investor confidence is destroyed by negative information in the markets.
A Look at the Pros …
Some reasons you might want to invest in a GIC:
- Stability of principal. As long as the insurance company issuing the contract is able to honor its obligations, the investment is guaranteed not to lose value. Maintaining your investment’s value may be particularly important if you’re in or nearing retirement.
- Source for borrowing money. Some plans allow you to choose which funds to use if you take a loan from the plan. Withdrawing from a GIC fund may be a good option since you won’t have to worry about selling stock or bond fund holdings at a low point.
- Diversify our portfolio.* A GIC or stable value fund may offer additional diversification to a stock portfolio. Diversification is measured by comparing value fluctuations in different investments. The goal is to have investments that are not highly correlated over time.
… and the Cons
There are potential drawbacks, too:
- Your principal may not grow enough to withstand the effects of inflation over the long term.
- The guarantee is only as solid as the financial strength of the insurance company issuing the contract.
- GIC and stable value funds may be less diversified than money market funds. They’re made up of loans to borrowers in the insurance industry; money market funds encompass loans to a wide range of corporate borrowers and the federal government. In general, having money in a variety of industries lowers risk because it lessens the impact of a downturn in any one industry.
A stable value or GIC fund can be an important component of the asset mix in your 403(b) plan. Review the options available in your plan to see if there is a stable value fund available, and be sure to read the prospectus to see if it is an appropriate investment for you. Remember to check out the fees. According to SmartMoney.com, fees for stable value funds typically run from 0.5% to 1% annually.
* Diversification does not guarantee a profit or protect against loss in a declining market.