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.

Comments

[I weep for ...:]

AIG was not bailed out by the Government, the Government took them over. There was no need to take the 80% interest in the company. That was a throw in. AIG just needed time to sell its assets a bridge. The core company (the international and domestic commerical insurance) is doing great, in fact operating at a bigger surplus than any other insurance company in the world. The non core can be sold for at least 180 billion. The Government, however, had AIG over a barrell on Wed with company facing bankruptcy because they could not raise the capital quick enough for the rating agencies and thus the government decided not only to loan the money but to also steal the company because they could. Now the shareholders rather pay back the loan to the FED and get the company back from uncle Sam. Also, that bad unrealized debt that AIG insured which caused the need to raise capital in such a hurry in the first place will now go away pursuant to the bailout so it will actually be a surplus rather than a debt for AIG. That debt will never be realized Thus, whomever gets control of AIG will have control of one of the best companies in the world.

2008 Sep 20 11:37 AM

[GEEKAY:]

So long as Chris Dodd, Barney Frank, and their ilk, insist that everyone "deserves" their own house, regardless of ability to pay the mortgage, the fundamental problem remains. The basic problem will not have been addressed, regardless ...

We need to convene a new Breton Woods Conference of those who understand money and finance issues, and take matters out of the hands of the politicians -- as much as possible. Establishing the value of underlying real property will be crucial, but hard (i.e., slow) to be accomplished. Preserving real property values is essential!

2008 Sep 21 12:00 AM