Stable-value funds are shaky 401(k) options

BOSTON (MarketWatch) � My sister Carole runs a small franchise business and recently started a retirement plan for her employees. She asked me to review the mutual fund choices she could offer.

Soon thereafter, she told me about the first workers to participate, and how they all had one thing in common.

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I blurted the answer before she could say it: �They all went into one fund � and it was the stable-value fund.�

I was right, not because I�m clairvoyant, but because too many people mix insecurity and a bit of laziness with the general fear they have about the markets and investing. Faced with a slate of funds, they saw the word �stable� and a promised return and said �Sign me up.�

Dull dollars

The good news is that they captured the full match on the money they pulled from their paycheck, but the bad news is that they would be fortunate to double that money over the rest of their working lifetime.

The Federal Reserve�s forecasts now suggest that interest rates won�t rise until late in 2014, while inflation rises at close to 2% annually. That should shake up the people who have their retirement savings in the ultra-safe options, because it�s basically a sign that they�re not going to make any real money over the next three to five years.

Click to Play Saving makes no sense

MarketWatch senior columnist Chuck Jaffe says the Federal Reserve is telling savers now that cash is trash, but many people might not like the alternatives. Photo: Getty Images.

Even when rates rise, a generation of workers will have had about 15% to 20% of their working career � key time for building a nest egg � where the ultra-safe investments barely kept pace with inflation.

The bulk of money going into retirement plans these days is ending up in life-cycle and target-date funds, which use an age-appropriate allocation to stocks and bonds, and which the U.S. Department of Labor has identified as an appropriate �default option� for retirement savers who don�t want to proactively select a portfolio on their own.

Many small employers have plans that lack target-date funds, mostly because the employer would face higher costs to get a plan with sufficient options to serve every age group on the payroll, while also offering a complete line of funds for the do-it-yourselfers.

In those cases, the oversized helpings of stable value are common � and that�s a problem.

Safety at a price

Stable-value funds are available only in 401(k) and other types of retirement savings plans. These are non-public funds � meaning the investor typically has a hard time researching them � that are supposed to hold a high-quality diversified, fixed-income portfolio which protects against interest-rate volatility.

Right now, of course, there�s no need to worry about rate volatility, because there is none and the Fed has made it clear there won�t be any for awhile.

�A lot of people in 401k plans are flying blind; they�re looking at names, and �stable� is a really attractive word in these markets,� said Christine Benz, director of personal finance at investment researcher Morningstar Inc. �There are some long-term benefits to having cash in your portfolio, to having an allocation to a stable-value fund, but you want it in small doses. People who put everything into the stable-value option may not lose anything, but they�re not going to reach their financial goals that way either.�

It�s not that stable-value funds are a bad option; in fact, the industry average return on stable-value funds is roughly 2%. That�s a far sight better than money-market funds, bank accounts and even many short-duration government bond funds, and also enough to stay even or ahead of the Fed�s inflation projections. The problem is that they�re a supporting player, rather than the lead actor in a portfolio.

�When you think about a new plan, a new hire and new money, they�re putting in small dollar amounts; in the beginning, they�re not really going to notice a real-dollar difference if they make 2% or 10%,� said Mike Francis of Francis Investment Counsel, a Wisconsin-based pension and retirement-plan consulting firm. �But when folks like that get into plans and never bother to look at them or receive further education, and go along their merry way for 10 or 20 years, what they�re missing out on adds up to never building something really significant.

�To make the most of retirement savings, they have to balance the risks and take chances that might look bad in one year or another, but that pay off over the course of their working life,� he added.

In recent market times, things that are emotionally difficult � staring down market risks, for example � haven�t necessarily paid off. Looking forward, it�s clear that doing the comfortable things � like going whole-hog into stable-value � won�t do much better.

�You have to think differently in this market environment, and that means diversifying more thoroughly in fixed income than in the past, and diversifying more all over,� said Tom Sakke, president of Caywood-Scholl Capital Management, a fixed-income firm in LaJolla, Calif. �The Fed�s message made that clear; the question is whether people who are playing it so safe were listening.�