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Special Report: Strategies for Volatile Markets | SAFETY

Weighing Bond, Stable-Value, GIC Possibilities

September 06, 1998|PAUL J. LIM | TIMES STAFF WRITER

The stock market's slide has exposed a glaring shortcoming in some 401(k) retirement plans.

Though employers have increased the average number of investment options in these company-sponsored plans from five to eight over the last four years, what they added were mostly stock funds.

By contrast, bond funds--a natural alternative when investors are seeking a relatively safer, income-paying asset--have gotten short shrift. In fact, many 401(k) plans still offer employees only a single bond fund option, said John Doyle, vice president at mutual fund firm T. Rowe Price Associates.

And even in plans that offer a choice of bond funds, "the average plan participant is still confused about how bond funds work--what makes them go up and down in value," said Shellie Unger, a principal at Vanguard Group's institutional investor unit.

The result: Scared 401(k) investors who pulled money out of stocks as the market sell-off intensified in the last two weeks redirected much of that money not into bonds but into so-called stable-value funds or old-fashioned guaranteed investment contracts--without necessarily knowing what these investments are and how they affect a portfolio.

A guaranteed investment contract, or GIC, is something like a certificate of deposit, but with significant differences. The company that writes the contract, generally an insurance company or a bank, promises the investor a certain interest rate over the life of the contract, which varies.

But don't let the term "guaranteed" fool you. Unlike with a bank CD, the principal invested isn't federally guaranteed. It is backed only by the insurance company or bank that issued it.

A stable-value fund typically invests in individual GICs. A growing number of stable-value funds, sometimes called "synthetics," also invest a significant portion of their funds in bonds. These investments are then "wrapped" in a contract by a bank or insurer that promises investors their principal won't decline in value.

According to Hewitt Associates, an employee-benefits consulting firm in Lincolnshire, Ill., 83% of the money that was yanked out of 401(k) stock funds last Monday--when the Dow Jones industrial average tumbled nearly 513 points--was put into GICs or stable-value funds.

By comparison, 11% went into bond funds and only 4% into money market funds.

Stable-Value Not for All

This past week, Cigna Retirement & Investment Services, the nation's third-largest 401(k) plan administrator, reported that 96% of its plan participants who fled stock funds put their money into stable-value investments.

That doesn't surprise Carol Glickman, an associate with Mercer Investment Consulting, a subsidiary of the consulting firm William M. Mercer in Los Angeles.

"Stable-value is always billed as the safest fund in a plan. So that's where those who are scared of losing any money are going to put it," Glickman said.

But even if it's the automatic choice, a stable-value fund or individual GIC may not be the right choice for investors seeking shelter from the stock market's swings.

First, a bond fund may be more appropriate--even though it carries the risk of principal loss--depending on an investor's goals and risk tolerance, experts say.

"To say that stable-value funds can replace bonds entirely is implying something that history shows is untrue," said Greg Schultz, a principal at Asset Allocation Advisers of Walnut Creek. "Short-term funds are not going to return as much as long-term funds over sustained periods of time."

Second, although a stable-value fund or GIC may be safe, it may not get you where you need to be financially in the long run.

Investors "don't realize the risk of putting all their money there is they won't have any money for retirement," Glickman said.

As with money market funds, stable-value investments are designed to preserve capital. They typically offer higher yields than a basic money-market fund, but over the long-term they provide less capital growth than stocks--and also than many bond funds.

Over the last 10 years, the average stock fund has delivered a total return of 13.2% a year, and the average taxable bond fund has returned 8.5% a year, according to fund tracker Morningstar Inc.

By contrast, the average return on the Hueler Stable Value investment index, which tracks about 30 of the largest stable-value funds, has been 7.25% a year in that period. Trailing that return is the 5.4% earned by money market funds.

With the exception of investors who need to tap all of their 401(k) money in less than five years, financial planners say most investors--even those close to retirement--should keep a significant sum in stocks, and avoid the temptation to invest too heavily in stable-value funds.

Why? Even the typical 65-year-old can expect to live at least 20 years after retirement. Odds are that, as in the past, stocks will provide far better growth over 20 years than what you'll earn in lower-risk stable-value funds.

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