On October 29, my colleague Scott Conking, head of Vanguard Institutional Investor Services, posted Getting Your Participants Safely Down Drawdown Mountain. Scott’s blog painted a compelling image of a plan participant fearfully looking down a steep ski trail. The man’s 401(k) ski lift had successfully transported him to the top of the mountain. But how was he going to safely traverse back down? In other words, having reached retirement, the plan participant was worried about safely drawing down his money. Scott tackles this issue with a thoughtful discussion about “retiree-friendly” plan design.
My blog builds on Scott’s observations by exploring one tool that may help employees who choose to stay in their plan after they retire. That tool is a stable value fund. Adding a stable value fund to your plan investment menu can make your plan more retiree friendly. A stable value fund generally provides the yield of a short- to intermediate-term bond fund with the price volatility of a money market fund, thus offering a conservative journey option for “getting down the mountain.”
Stable value funds invest, directly or indirectly, in high-quality, short- to intermediate-term fixed income investments. They are distinguished from bond funds by maintaining a constant $1 share price net asset value (NAV). These fixed income investments are covered by wrapped contracts that are purchased from financial institutions—typically insurance providers—to smooth earnings volatility. This allows the stable value fund to use book-value accounting rather than market-value accounting, permitting the fund to maintain the stable share price. As with most insurance policies, there are certain restrictions and limitations.
While stable value funds dampen price volatility and ensure a minimum return of 0%, the cost of the insurance may detract from the long-term total return of the bond portfolio. For savers in the plan, bonds tend to reduce equity risk, so it may not be worth the additional cost for the insurance wrap. However, for retirees who want to avoid moguls as they draw down on their balance, they may appreciate the lower volatility and principal protection provided by a stable value fund.
How to evaluate stable value fund options
Even though all stable value funds aim to maintain a $1 NAV, not all of them are the same. Here are some things to consider when selecting a stable value fund.
First, look for a team with specific stable value industry expertise—one that has weathered many market cycles. You want a team that understands stable value from a contractual perspective, as each contract is a separate negotiation. Additionally, having access to an experienced credit team is key when building and managing the underlying bond portfolio. It’s also important for the selection of and allocation to insurance company wrap agreements.
The best measure of risk in a stable value portfolio is the market-to-book value ratio because it shows exposure to the insurance providers. The stable value fund you select should have a strong risk control strategy. For example, Vanguard Retirement Savings Trust (RST) controls risk by investing in highly rated bonds with a minimum credit rating of single A, while other firms will invest in bonds with a lower credit rating. Also, Vanguard has a credit quality bias with our wrap providers and diversifies across a high number of providers where other firms may have a more concentrated portfolio.
While past performance is not indicative of future returns, a strong and consistent track record of performance versus other comparable stable value funds should be a factor to consider. In this respect, Vanguard RST has consistently outperformed the competition as illustrated in the chart below.
Notes: Retirement Savings Master Trust returns are gross of management fees and net of contract fees. Its expense ratio was 0.28% as of September 30, 2018.
Vanguard stable value
Vanguard offers several stable value alternatives that may be right for your plan. Are you interested in learning more about Vanguard stable value? If you’d like more information about designing a retiree-friendly investment lineup for your 401(k) plan, our experts can help. Please reach out and consult with your Vanguard team, or if you are new to Vanguard contact us at 800-523-1036.
- A stable value investment is neither insured nor guaranteed by the U.S. government. There is no assurance that the investment will be able to maintain a stable net asset value, and it is possible to lose money in such an investment.
- Vanguard Retirement Savings Trust is not a mutual fund. It is a collective trust available only to tax-qualified plans and their eligible participants. Investment objectives, risks, charges, expenses, and other important information should be considered carefully before investing. The collective trust mandates are managed by Vanguard Fiduciary Trust Company, a wholly owned subsidiary of The Vanguard Group, Inc.
- All investing is subject to risk, including possible loss of principal.
- Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.