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Why Investors Choose Stable Value

Stable value is one of the most popular investments in defined contribution plans today. The Hewitt 401(k) Index™ reports that stable value funds represent roughly 20 to 25 percent of all defined contribution plan assets, even though not all plans have a stable value fund available. In fact, Hewitt reports that stable value's share of 401(k) assets are in line with the amounts invested in U.S. equities and company stock.¹

So why do stable value funds attract such a large share of defined contribution investors' nest eggs?

The answer is that investors today have to shoulder most of the burden for saving and investing for their retirement, and they are very concerned about the risk of losing money in the stock and bond markets. Because stable value funds provide attractive and consistently positive returns, these funds have become an important tool with which retirement investors can build a more balanced and risk-controlled nest egg.

Stable Value Fund Characteristics:
For more than thirty years, stable value funds have provided consistent performance for defined contribution retirement plan investors in public and private employer-sponsored retirement plans. Despite the ups and downs of the financial markets, investors in stable value funds have never lost money. By itself, this makes stable value funds very attractive to investors. But stable value funds provide other benefits as well:

• Returns that are generally higher over the long-term than money market funds and cash.
  Stable value funds outperform money market funds during most market environments, as illustrated in the following chart.
  Stable Value Funds Earn Higher Returns than Money Markets
  1/31/1990 to 2/28/2006
• Less risk to principal than bond funds.
  Stable value funds provide higher returns because they hold intermediate-maturity investments plus companion wrapper agreements that provide protection of principal and accumulated earnings for investors. As a result, stable value funds tend to produce long-term returns that are comparable to intermediate-maturity bond funds. Unlike bond funds, however, stable value funds do not fluctuate in value with changes in interest rates, so their volatility or risk is substantially less than that of a bond fund.
  Stable Value Funds Earn Higher Returns than Money Markets
  1/31/1990 to 2/28/2006
  
  These characteristics help explain why, when defined contribution plan investors have access to a stable value fund, they allocate 33 percent of their total 401(k) savings to stable value.²

What Is a Stable Value Fund?
A stable value fund is a conservative investment vehicle that is available in more than half of all defined contribution employee benefit plans. It is used by defined contribution plan investors to provide principal preservation and stable returns that are in line with the long-term returns of intermediate bonds.

Stable value funds invest primarily in diversified portfolios of intermediate-duration, investment-grade fixed income securities. The average quality of these funds is typically AA+ or better. Stable value portfolios are covered by wrapper agreements that provide return stability and preservation of principal and accumulated earnings.

Why Investors Want Stable Value:
In addition to the desirable investment characteristics that stable value funds offer, there are several societal trends are fuel investors' consistent commitment to stable value: the equity bear market, the aging of the population, the shift in responsibility for retirement savings, and investors' awareness of investment risk.

• The Equity Bear Market Made Investors More Cautious.
  The recent bear market in equities caused many investors to recognize that it is crucial to have a balanced portfolio in order to protect their nest eggs from the volatility of the equity market. Flows into stable value funds increased significantly in the past several years as investors recalibrated their portfolios to include a higher percentage of conservative assets and bring their risk exposure in line with their true tolerances. To illustrate, the allocation to stable value funds of total defined contribution assets for plans participating in the SVIA survey grew from 23 percent in 1997 to 33 percent in 2002 and have stayed at that level since then.³


• Stable Value Use Increases as Investors Get Older.
  Stable value is popular with investors of all ages, but as the chart below illustrates, it is most popular with older investors⁴. Allocation to stable value for the 60s age group reaches 21.0 percent compared to 12.1 percent for all ages in the survey.⁵

  Average Assets of 401(k) Accounts by Participant Age, 2004 6 Percent of Account Balances
  Age	Equity Funds	Balanced Funds	Bond Funds	Money Market Funds	Stable Value Funds	Company Stock	Other	Unknown	Total
  20s	51.6	13.0	9.0	5.1	6.0	12.6	1.3	1.4	100
  30s	56.1	10.3	8.3	3.6	5.4	13.5	1.5	1.3	100
  40s	50.9	10.2	8.7	3.6	8.4	15.4	1.7	1.1	100
  50s	43.8	10.3	10.3	4.1	13.3	15.1	1.9	1.2	100
  60s	36.5	9.5	12.3	4.8	21.	12.6	1.9	1.4	100
  All	46.4	10.1	9.8	4.0	12.1	14.5	1.8	1.3	100




• Investors Take on More Responsibility for Retirement Savings:
  The U.S. retirement system used to be described as a "three-legged stool" comprised of Social Security, an employer-provided pension, and individual savings. For this system to work, all three legs need to be equally strong and balanced. However, with the enormous financial pressures on Social Security and defined benefit pensions today, the U.S. retirement system is fundamentally out of balance.
  
  Social Security is not sustainable under its current rules. Projections show that unless it is reformed, it will be able to cover only 74 percent of program costs after 2041, when the vast majority of baby boomers will be drawing benefits.⁷
  Employer-provided pensions have also undergone a major transformation over the past 20 years. Increasingly, defined benefit plans that promise a percentage of salary as a retirement benefit have been replaced with defined contribution plans that provide a self-directed savings vehicle. This has shifted the investment risk from the employer to workers who have little investment experience or training.
  
  An increasingly mobile workforce also means investors have a temptation to spend rather than preserve retirement savings each time they change jobs. In fact, the Congressional Research Service reports that 14.3 million workers have been faced with the choice of spending or rolling over retirement savings at least once since 1998. The benefits of stable value are increasingly denied to job changing investors since investors roll over retirement savings predominantly into Individual Retirement Accounts (IRA).
  
  Additionally, almost half of the workforce, 51 million Americans, do not participate in or have access to a retirement plan. These individuals have been unable to utilize stable value funds to reduce risk and increase the returns on their retirement savings.
  
  
• Investors Are More Aware of Investment Risk:
  All of these investors are hungry for investment vehicles that help to mitigate their investment risk without sacrificing returns, as evidenced by the popularity of stable value funds in 401(k) plans and the rapid growth in stable value funds. In fact, investors' sensitivity to risk was documented in the SVIA 2002 Conservative Investment Survey.⁹ The survey found a surprisingly low tolerance for risk among 401(k) investors, with only 7 percent reporting they were willing to take a substantial risk for a substantial gain.¹⁰ The majority (64 percent) of 401(k) investors were willing to take a moderate amount of risk in exchange for a moderate return. Twenty-eight percent said they would only take a small or minimum amount of risk, even if it reduced the money they would make on their investments.¹¹
  
  Not surprisingly, retirees are more risk sensitive than 401(k) investors since they have fixed incomes and readily understand that a loss can mean a reduction in their standard of living. The majority (58 percent) of retirees preferred a retirement investment portfolio that allows them to take the least amount of risk necessary to achieve a steady stream of income.¹² Only 37 percent of retirees were willing to take a moderate level of risk in order to receive moderate returns, and 1 percent reported a willingness to take a high level of risk in hopes of having high returns on investments.¹³
  
  Stable value's characteristics of principal protection, dependable income generation, and diversification struck a cord with the majority of survey respondents: retirees and 401(k) investors as demonstrated in the table below.¹⁴
  
  

  Appeal of Stable Value Fund Characteristics15
  Investment Characteristics	401(k) Investors	Retirees
  Important to have some of your retirement money in investments that guarantee you will not lose your principal	63%	69%
  Important that a portion of your money for retirement is in investments that provide a dependable rate of return	59%	66%
  Important that you minimize the risk to your original investment	34%	54%

Can Stable Value Be a Wrong Choice for Investors?
Despite the trends discussed, stable value can be a wrong for investors focused only upon return. Clearly, return-driven-only investors should avoid stable value funds and other conservative investments, since they cannot provide the higher returns associated with higher risk investments.

Investors who want to market-time should also avoid stable value for two reasons. Stable value funds provide steady or 'stable' returns, which means that as interest rates rise, stable value will too. However, stable value funds can trail other conservative investments in a rapidly increasing interest rate environment. This characteristic also explains why stable value funds typically impose trading restrictions, which prevent arbitrage opportunities with other competing conservative investments like bonds or money markets.

Conclusion: Why Choose Stable Value?
Given our societal trend toward having workers bear the investment risk and responsibility for their retirement savings, an investment vehicle that provides bond-like returns, money market-like volatility and liquidity, and low correlation with equities is a critical tool in helping investors provide for their own retirement security. These investment attributes are present in stable value funds, which defined contribution investors have appreciated for more than thirty years. Clearly, stable value funds will continue to play an important role in helping Americans save for their retirement and achieve their goals for retirement security.

¹Hewitt 401(k) Index™ Observations 1997 to November 2005
²Nineth SVIA Annual Stable Value Fund Investment and Policy Survey. Washington, D.C.: Stable Value Investment Association, 2003, pages 1-3. The survey covers $419 billion in stable value fund assets offered in 97,854 defined contribution plans and representing a 33 percent allocation of total 401(k) assets as of December 31, 2004
³Seventh, Eighth and Ninth SVIA Annual Stable Value Fund Investment and Policy Survey, Ibid., page 3.
⁴Investment Company Institute Perspective Web-Only Edition "401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2004" by Sarah Holden and Jack VanDerhei, Volume 11, Number 4a, September 2005, page 15. The data summarized covers 2004 and 16.3 million 401(k) investors in 45,783 plans with $926.2 billion in assets.
⁵Ibid., page 15
⁶Ibid., page 15. Please note that the ICI data on asset allocation to stable value differs from the SVIA survey data because the respective surveys cover different samples. The SVIA survey includes 97,854 plans, all of which have with a stable value option with total assets. The ICI survey includes four investment plan types, with only two containing a stable value option. The ICI reported that allocation to stable value rose respectively to 21.5 percent for plans that had equity, bond, money market or balanced funds, and stable value; and to 20.1 percent to plans that offered equity, bond, money market and/or balanced funds, company stock, and stable value.
⁷2005 Annual Report of the Board of Trustees of the Federal Old Age and Survivors Insurance and Disability Insurance Trust Funds. Washington, D.C.: U.S. Government Printing Office, 2005.
⁸CRS Report for Congress, "Pension Issues: Lump-Sum Distributions and Retirement Income Security," Updated June 30, 2003, Patrick J. Purcell, Specialist in Social Legislation, Domestic Social Policy Division, page 8.
⁹SVIA Conservative Investment Survey. Washington, D.C.: Mathew Greenwald & Associates, Inc., June 21, 2002, pages 5-7. The survey focuses on trying to better understand the need for secure, low risk investments, as well as gauge the level of familiarity and appeal of stable value funds. Greenwald and Associates conducted the survey in May 2002 through a 15-minute national survey with 401(k) investors who participate in their employer's retirement savings plans and retirees who had saved at least $5,000 in their former employer's retirement savings plans.
¹⁰Ibid., page 19.
¹¹Ibid., page 19.
¹²Ibid., page 42.
¹³Ibid., page 42.
¹⁴Ibid., page 66.
¹⁵Ibid., page 66.

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