When investing in a 401(k), it is important to balance the risk of loss with the reward of higher returns. If you want to err on the conservative side of the investment spectrum, there are several ways to protect your principal and ensure that the money you put aside for retirement will be there when you need it.
Stable Value Funds
Most 401(k) plans include a stable value fund, and that fund is designed for absolute safety of principal. Stable value funds provide protection of principal by investing only in safe investment vehicles, eliminating the chances that the value of the investment will go down. They tend to invest in high-quality government and corporate bonds that don't necessarily grow over time, but they don't lose value either.
As with all safe investments available to 401(k) investors, the risk with a stable value fund is that the return will not keep up with inflation over the long run. In the end, the principal will be protected, but you might lose buying power to the erosive force of inflation.
Read More: Advantages & Disadvantages of Government Bonds
Money Market Funds
Money market funds are a type of mutual fund. They are designed to keep your money safe by maintaining a steady share value. These funds only invest in safe short-term instruments, cash and cash equivalents. This allows them to maintain a stable value and avoid undue risk.
The downside of having your money in these safest mutual funds is that the interest they pay tends to be very low. Also, while they generate income, there is little to no capital appreciation. While the principal remains safe, there is always the risk that the fund will not keep up with inflation and that you will actually lose purchasing power over time.
Read More: Types of Money Market Securities
Government Bond Funds
Government bond funds offer absolute safety of principal, since they are backed by the full faith and credit of the United States government. Many 401(k) plans offer a fund that invests in a number of different Treasury instruments, including Treasury notes, Treasury bills and savings bonds.
Some funds might also invest in Treasury Inflation Protected Securities, also known as TIPS. These securities provide a fixed rate of interest, plus a pass-through payment equal to the consumer price index. Investors who are worried about future inflation might want to seek out a government bond fund that holds a percentage in TIPS.
Read More: Advantages & Disadvantages of Treasury Bills
High-Grade Corporate Bond Funds
As the name suggests, high-grade corporate bonds are on investment-grade bonds issued by corporations. They tend to have a better return than government bonds, but they also lack the guarantee of U.S.-backed Treasury bonds.
Bonds are generally considered safer than stocks, however, since bondholders are secured creditors while stockholders are unsecured creditors. That means that the bondholders are paid first in the event of a bankruptcy.
By sticking with highly rated corporate bonds, 401(k) investors can reduce their risk further while boosting the return on their money.
Based in Pennsylvania, Bonnie Conrad has been working as a professional freelance writer since 2003. Her work can be seen on Credit Factor, Constant Content and a number of other websites. Conrad also works full-time as a computer technician and loves to write about a number of technician topics. She studied computer technology and business administration at Harrisburg Area Community College.