Softpanorama (slightly skeptical) Open Source Software Educational Society

May the source be with you, but remember the KISS principle ;-)

"All money in cash/stable value fund"
or "Depression might start tomorrow" strategy

1. Introduction
2. Popular 401K investors delusions
3. Fashionable mutual funds mix
4. Follow the leader
5. Naive siegelism
6. "Financial alchemist" strategy
7. Stable value only or "Depression might start tomorrow" strategy.
8. Bonds-based strategy
9. "Gold always shines bright"  and "Commodities rulez" strategies
10. Lifecycle strategies
11. Economic cycle based market timing
12. Combination of lifetime strategies with market timing.
13. Conclusions
14. Webliography
15. Old News

This is essentially the strategy opposite to Naive Siegelism and the key idea "put all your money in a money market/stable value fund" is also very simple and attractive.  I believe it's wrong and small doze of other investment can enhance returns and preserve peace of mind, but I would be the last to argue that peace of mind is not indirect dividends (look at my effort which was triggered by losses during dot-com bust ;-). 

If you really are risk averse, why not just save your 401K into stable value fund, you still get your tax relief, it’s worth it just for that. Plus you get you company contribution (say, 4% of salary) which can be counted as a return on investment too.

Sometimes peace of mind is worth more to an individual than a high return.  Ability to sleep at night is priceless.  And this is not just a metaphor. As CNN reported pm Oct 28, 2008 (Money worries rob workers of sleep, study shows)

Nine of 10 American workers are losing sleep over financial worries, according to a survey released Monday by a company that helps workers deal with wellness issues.

Thirty percent of respondents reported worrying about the cost of living while 29 percent cited credit-card debt.

Keeping up with the rising cost of living and credit card debt were top concerns preventing people from falling asleep, according to the results from ComPsych Corporation, which surveyed employees of companies it serves. Thirty percent of respondents reported worrying about the cost of living while 29 percent cited credit-card debt.

Making mortgage payments and building retirement accounts also kept people awake, with 14 percent and 13 percent, respectively, listing those as their main concerns, the survey said.

How to afford childrens' school tuition and health care costs robbed just three percent of sleep, the survey said.

Only eight percent of respondents said they are not worried and have no trouble sleeping.

The study was compiled and released by ComPsych Corporation, which contracts with companies to provide employee assistance programs.

"As the largest EAP, our increased call volume has been a reflection of the financial stressors faced by U.S. employees," said Richard Chaifetz, ComPsych's chief executive officer.

According to Vanguard approximately 13% of participants in 401K plan had their entire accounts in fixed-income securities.  Money market (stable value) funds are definitely preferable to bond funds if yields are less then 5%.  They also preferable in time of financial crisis, You can see what happened with bond funds in October 2008;  it's not pretty.

There is some theoretical justification of this strategy: The fundamental cause of any credit crisis is that risk and reward became disconnected. And that can be true not only for stocks but for bonds too. If yields before the crisis are too low (as they were in 2006-2007),  corporate bonds can be decimated too. for example LQD, a popular ETF that invests in investment grade bonds at one point lost 30% of its value dropping from 107 to 81.70. . Also people who from Jan 1, 2006 contributed all their 401K contribution to stable value fund has had on Oct 27, 2008 65% more money then people who contributed all their money to S&P500 based fund (assuming Vanguard stable value fund and 2.5% yearly increase in salary for each calendar year). Just think about it: 65% less money...  OK, this was so far the worst day in 2008 but still...  

But it is clear that this strategy can be enhanced by investing a  small amount  (let's say up to 10 or 20%) in other instruments, which increases return without substantial increase of risk (assuming 50% decline in case of 10% investment you will get 5% decline of the total; in case of 20% investment it can be up to  10% decline).  You can invest small amounts (like 3-5% for each instrument) in TIPS, junk bond and stocks: 

• TIPs is small dozes (say, up to 10%) can also be a very good complement for stable value providing both higher returns and opportunity to trade them without violating rules of particular 401K plan. That key here is not to be in a hurry and buy them only on dips and sell on rallies (once in three-five years TIPS have really large movements, like happened in 2008). The most important is to understand that in no way you should exceed a given limit and resist inclination of becoming  a greedy yield hog (bulls can make money, bears can make money, pigs never can) and rush for additional 50 beeps of total return.  If you select this strategy you essentially decided that "peace of mind" comes before returns posture and it is unwise to betray this strategic position.
• Junk bonds in very small does (3-5%) are also can be considered to be a valuable addition but remember that they are as volatile as stocks. Still like medicine in very small dozes (let's say 5% or less) they like TIPS tend to  increase 10 years returns with only minimal increase of risk if you are patient enough to buy them on dips, say 10% or more from 1000 days average.  But junk bonds returns depends whether those companies that are behind them die like fly on the frost in severe recession or survive;  I watch only Vanguard High Yield fund and hope that most components of this fund by-and-large will survive the current slump. But 2009-20010 probably will provide an interesting field test for this hypothesis.
• Stocks are also can be considered although they are more questionable in the current circumstances. Investing of just 5% in diversified stock index has advantage that you do not need to buy them on a regular basis and can well wait for a crashes like the one in October 2002 or October 2007 and pick 1%-2% really cheap (you do not need to buy more then that -- in good case you can expect them to double in value in a couple of years). Why pay $150 per share of SPY if once in five years or so you can pick up those share for $80 or less. Then you can wait for a couple of years and sell it for $130 or so. as they are not principal for your investment strategy. Even if there will be no recovery you still risk 5% or less of your holdings.  But stocks might be a thing of part after the current crisis and returns might suffer for a decade or so like was the case with Japanese stocks.  Just do not be greedy and  buy them in small chunks (cost averaging on dips, so to speak) : good timing is impossible and if you bought S&P500 for say $86 on October 24 that does not means that it cannot be $70 later the same month. 

But the main danger here is not leaving all the money in stable value account. It is the danger of abandoning the strategy in futile (and usually counterproductive) attempt to increase returns. This happens if stocks produce spectacular returns and the investor start moving money to more risky investments due to greed. And this is probably the worst moment of moving money to bond funds as yields are low and risk is high.  Especially dangerous are  junk bonds which actually behave like stock and can crash 50% or more.  Usually people move funds from stable value when stable value fund returns became really miserable. But this is a really bad (completely wrong) time as bonds are overvalued at this moment and, for example, the yield spread between junk and high quality usually becomes very narrow.  That means taking disproportionate amounts of risk and this is a huge costly mistake that costs some people up to 30% of their 401K saving (Vanguard High Yield fond is a toast as of October 2008, dropping from   $6.30 to $4.47). This drop will only partially be compensated by higher yield and in lucky case it can take five of more years to recover (this is average term to maturity in this fund). 

We probably should respect those people who used "all stable value"  strategy:

• they just refused to play in the Wall Street casino and enrich brokers (fees for stable value are usually quite reasonable something like $50 for $100K invested per year; compare that to 0.5% charges by PIMCO Total Return, which BTW is down for a year in October 2008) 
   

  We probably should respect those people who used "all stable value" or all bond strategy: they just refused to play in the Wall street casino and enrich brokers.

• They preferred "peace of mind" to rat race and will not spend too much time watching financial news and analyzing obscure charts. There are a lot of more productive and enjoyable activities in this world, especially for good programmers  ;-). I would like to stress it again that you can enjoy life and not to think about recent drop of S&P 500: amount of time stock investors spend on reading market news and other investment crap can be completely disproportionate and can became real and pretty bad addiction.

  Another nice feature of this simple strategy is that you can enjoy life and not to think about recent drop of S&P 500

• As of 2008 it's premature to declare stable value fund investors losers as for the last ten year period  (assuming cost averaging from zero balance) ending in 2008 their investment outperformed "all S&P500 investment"   by a considerable margin (7%-40% defending on he month; any yes there was a point at which stable value outperformed S&P500 by 40% -- October 10, 2008).
• 401K plans are stacked against investors and brainwash them to put money into stock funds:
  Here is how situation was desribe in blog The Mess That Greenspan Made   on  November 13, 2008 (401k Death Watch):

  As if retirement planning (in general) and faith in equity markets (in particular) didn't have enough working against them right now, it seems a small, but growing, number of businesses are foregoing their 401k matching contributions in order to conserve cash (and jobs).

  Having left the confines of traditional employment almost two years ago, those year-end five percent matching contributions are sorely missed.

  What is not missed, however, are the restrictions that most 401k plans impose along with the constant prodding to fill up those Morningstar style boxes with more U.S. equity funds.

  How's that workin' for ya, as Dr. Phil would say.

  It seems that the 401k industry is in a rough patch at the moment with world-leader Fidelity Investments announcing huge layoffs and a growing number of plan participants opting to scale back or stop contributing to their retirement account.

  Those stable value funds may be their only saving grace in the period ahead.

  News comes in this BusinessWeek story about the growing number of companies that are eliminating their matching contributions.

There can be additional incentives to adopt this strategy, especially in crooked 401K plans (and too many of 401K plans are crooked). In such bond funds in 401K plan have high expense rations (Wal Mart 401K plans are one such example; see Some stock funds can't even outperform lowly T-bills ):

You'd be amazed at how much work it can take to make a stock portfolio give T-bill returns — and how many funds have managed to make the leap from the merely mediocre to the truly dreadful.

A basic tenet of investing is that, over the long term, stocks tend to return more than bonds or T-bills. The past 10 years have borne this out.

• T-bills have gained an average 3.7% a year from November 1997 through November 2007, assuming you reinvested your interest.

• The Lehman Bros. U.S. Aggregate Bond index, a broad measure of the bond market, has returned an average 6.1% a year the same period.

• The Dow Jones Wilshire 5000 index, which measures the returns from virtually the entire stock market, has risen an average 6.6%.

As for "depression might start tomorrow" this is more often then not a paranoia. For example different people access chances of recession differently in April 2008 and nobody knows can it turn into depression or not. Hopefully not. According to Vanguard's Center for Investment Research, investors think that there's a 51%  chance that U.S. stocks will lose a third of their value in any given year.

Based on historical returns (which as we all know does not predict the future events), Vanguard calculates that the real probability of that happening is about 2%.  Even if we assume 20% risk of the recession with 33% drop in stock instruments,  holding 100% of your money in stable value fund might be an overkill. some percentage that feels comfortable to you should probbaly be allocated to more ricky instuments.

Created May 16, 2003; Last modified: November 13, 2008