How safe is too safe

Question: Are stable-value funds a safe investment? —Rexford, Syracuse, New York

Answer: That depends on what you mean by safe.

Stable-value funds, which are available only in 401(k)s (and currently offered by more than half of such plans), invest for the most part in high-grade short- to intermediate-term bonds. The managers of these funds also buy “wrappers” - or contracts from insurance companies and banks - that guarantee principal and accumulated interest against loss.

As a 2007 study shows, the result is an investment that provides long-term returns similar to those you would get with intermediate-term bonds, but with stability comparable to a money-market fund’s.

Would I put stable-value funds in the same category as FDIC-insured bank deposits when it comes to principal protection? No. They’re not federally insured. But given the high quality of the funds’ underlying securities and the fact that they also diversify risk by purchasing wrappers from 10 or so financial institutions on average, I think it’s fair to say that stable-value funds provide a high level of security and adequate protection against losses.

So in that sense I’d say yes, they’re a safe investment.

Playing it too safe

But when it comes to investing for retirement, I believe you should to take a broader view of safety. Specifically, you’ve got to consider whether your investments are safe in the sense that they’re likely to deliver the returns you’ll need to build a nest egg large enough to support you comfortably in retirement.

And that’s where I think people who’ve been flocking to stable-value funds lately - in September alone, 401(k) investors switched $921 million out of stock funds and moved $733 million into stable-value funds - have to be careful.

Understandably everyone is freaked out about declining balances of 401(k)s. Those losses and fears that even more may lie ahead make investments that promise security especially appealing today. But you don’t want to plow too much of your money into investments that offer a refuge from market losses.

There may be few concepts you feel you can count on in the investing world today. But here’s one you can bank on: The more secure an investment is, the lower its long-term returns are likely to be. So by focusing too intently on safety in the short-term, you could jeopardize your long-term retirement security by sacrificing growth potential.

Which is why I think you shouldn’t view stable-value funds as a haven to flee to during periods of market turmoil, but as a core part of a diversified portfolio that also includes stocks and bonds. Basically, you should consider stable-value funds an investment choice for the fixed-income portion of your 401(k), along with bond funds.

As for how much of your 401(k) you should put in stable-value and bond funds, the answer largely comes down to how far along you are in your career and how much risk you’re comfortable taking. I know everyone is wary about investing in stocks right now. But if you’re young and early in your career, you don’t have to be so concerned about falling stock prices. You’ve got decades before you’ll tap your 401(k), so you should focus on getting a competitive long-term return. And that means keeping most of your money in stocks.

Although there’s no assurance stock prices won’t fall even farther from here, history shows that you’re likely to earn the best long-term returns from shares you buy in the wake of major market declines.

As you get closer to retiring, you still need long-term growth - after all, you may spend 30 or more years in retirement - but you also want more stability. You don’t have as much time to recoup losses. So you want to gradually increase the amount going into stable-value funds and bonds as you age.

So if it’s safety you’re looking for, yes, stable-value funds can be a reasonable choice. But make sure they’re part of a long-term investing strategy. Otherwise, the price of feeling safe today could be less retirement security down the road.