Thursday, September 18, 2008

Part 3 - Time to be conservative with your 401K

Worried about your 401K? Should you be?

I have written two previous posts focused on being conservative in your 401K during these turbulent days in the stock market (read Part 1 or Part 2). The basic concept was that you should lighten up on stocks and allocate a larger percentage, as much as 50%, to a stable value fund. In this manner, you would be obtain somewhat higher interest rates than would be available from a money market fund or Treasury bond fund while preserving capital.

Now we have stories in the news about money market funds "breaking the buck" and it is causing many investors to wonder, not only about their money market funds, but also about how stable their stable value funds actually are. The concern is well-placed given that:

  1. Fannie Mae and Freddie Mac bonds (known as agency debt) are often found in stable value funds
  2. AIG is a major player in stable value funds and provides "wrap" contracts that protect against loss of principal for some 10% of all stable value fund assets across the industry.
We all know the government has essentially taken over all three entities, throwing stock markets worldwide into turmoil.

Thankfully, the government is still standing behind Fannie and Freddie's debt and that has been reassuring bond holders. So what about the AIG connection?

Today's Wall Street Journal attempts to calm investors fears. It goes on to explain:
"In stable-value wrap contracts, the fund assets are not held in the insurance company's general account. They're owned and controlled by the plan. And in stable-value funds that hold AIG wraps, AIG would typically be just one of many wrap providers. "If something were to happen to one of those wrap providers, it doesn't really change anything in the stable-value portfolio other than the manager has to decide to reallocate those dollars to a different wrap provider," says Kelli Hueler, CEO of Hueler Analytics."
This is reassuring but it does not imply that stable value funds are immune to the current financial environment. Interest rates can be expected to decline as fund managers opt for less risk and less return. As the journal says:
"With greater market risk, wrap providers may become more conservative and insist that stable-value funds' underlying portfolios have higher credit quality and liquidity, likely lowering returns."
In summary --

So it appears that stable value funds dodged another bullet. With returns likely to decrease, however, there may be less advantage to holding these investments when compared to lower yielding but ultra-conservative government bond funds that are also generally offered in many 401K plans.


Source: Money-Market, Similar Funds Appear Solid Amid Carnage



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