Stable Value or Money Market? What's best for your plan?

Money Market has been paying practically nothing in returns while Stable Value funds have demonstrated superior returns for much of the past decade, and stable value funds are only made available to investors through a company-sponsored retirement plan. But, these two products couldn’t be more different.

Your plan likely has one or the other, to serve the same purpose. So what are they and what’s the catch? Let’s take a closer look.

The money market account many of us are familiar with is an SEC-registered product investing in short term, high-quality securities, cash, and other highly liquid instruments. These funds offer high liquidity with a very low level of risk.

The goal of the money market fund is to provide liquidity at the drop of a hat and maintain a net asset value (NAV) of $1 per share. It should be noted that these funds do not guarantee the principal and they work just like any mutual fund – they issue redeemable shares to investors.

This investment is generally used by those who are risk averse or willing to accept low returns in return for stability. Any earnings made on the investments above $1 per share NAV are transferred to the owner as a dividend. In combining short terms with higher quality investments, the goal is to help manage the risk investors are exposed to. These funds only have two levers they can pull to increase dividends: 1) they can increase the term and thus decrease the liquidity; or 2) decrease the quality and increase the risk. The problem with this is that whenever you pull one or both of these levers, you essentially eliminate the whole point of the investment.

There’s also the risk that a money market fund may fall below the $1 NAV. This rarely happens, especially since the SEC issued new money market rules after the 2008 crisis to better manage money market funds. Those new rules outline tighter restrictions on portfolio holdings as well as provisions for imposing liquidity fees and suspending redemptions. The Fed and US Treasury have historically shown a commitment to stepping in to assist as a backstop, but that cannot be relied upon.

Ultimately, this means money market dividends are stuck relying on the current interest rate environment. And in case you’ve been hiding under a rock, they’ve been really low! When looking back at the past 10 years, many money market account returns have been less than 0.50% on average. That’s a problem when inflation has hovered around 2%; you’re actually effectively losing money because your returns aren’t keeping up with inflation.

Surely there has to be a better option?

And that is where the stable value fund steps in. Stable value has the ability to pull the levers we mentioned above and increase the term of the underlying investments or decrease the quality of the underlying investments all while being able to maintain that same $1 per share stability. (Technically there is no such thing as a NAV in a Stable Value Fund. The equivalent term is “book value.”).

In a stable value fund, the deposits made by participants are used to invest in a portfolio of short- to medium-term bonds and guaranteed investment contracts. Because of the longer terms and broader range of investments, the value fluctuations tend to be greater on a day-to-day basis in reaction to what is taking place in the market. What’s interesting about a stable value fund is that even though the market value of the underlying investment fluctuates, the book value does not. The owner of a stable value fund will continue to receive the agreed-upon interest payments regardless of the state of the economy. It is the only principal preservation option that provides a contractual rate of return to participants.

As a result, many stable value funds during the past 10 years have performance numbers that are four to five times higher than that of a money market fund. (The holdings are more susceptible to changes in interest rates than money market holdings, so it is possible that stable value could lag in rising interest rate environments.)

Wondering how that’s possible? The book value remains constant due to an insurance contract that is “wrapped” around the investment portfolio to negate the differences between the underlying investments and book value. It makes sense that this insurance contract is most valuable when the underlying portfolio value dips below the book value of the investments. In this scenario, the insurance wrapper provides assurance to the participant that they will get their principal investment back because the insurer must compensate the fund for any losses.

So why doesn’t every organization with a 401(k) plan use a stable value option instead of a money market fund? The first consideration is the risk. As outlined here, stable value carries a higher risk than money market. Step one in a plan sponsor’s prudent process should be, is the plan sponsor willing to accept the additional risk and are the participants? The second step is selecting which stable value fund.

Stable Value Funds have some other unique characteristics (which differ dramatically from one provider to the next) including:

• The fees associated

• The type and number of wrap products that are being used to insure the stability of the book value and the liquidity for participants

• The historic returns of the fund, how the credit rate(s) are determined and how often are they set

• The quality of the underlying portfolio of securities or sleeves of investments and their managers

• The number of investment and insurance companies involved (this can be anywhere from one company using the general account to ensure the returns or as many as 10 or more companies managing different sleeves of money within the fund)

• The insurance company (wrap provider) current and historical financial strength along with its regulatory status

• Equity wash rule provisions affecting other investments in the plan

• Termination provisions to leave the fund

Plan sponsors need to weigh the needs of plan participants with what makes sense from a prudent risk-taking standpoint and engage in a process to select and monitor investments. Stable value funds can offer far superior returns, but with some additional risk. This is where an advisor specializing in retirement plans can help. It’s our job to help you evaluate these factors and what makes sense for you and the participants in your plan.

Interested in learning more or need help evaluating the Stable Value Fund in your 401(k) line up? Give us a call. We’d love to talk through your options with you.

Related Articles on other investment considerations for your plan: Moving Target With Target Date Funds