The Best Conservative Investment Options in the CT State 457 Plan
If you are a CT state employee, then you have to opportunity to invest in the 457 plan. The 457 plan has a limited set of investment options, and I went through and determined the best conservative options available. I thought this was appropriate as we have a potential recession on the horizon with a high-level of inflation and Restrictive monetary policy. Therefore, if you have a 457 plan then I’d suggest you read through to see what I think are the best conservative investments within the plan.
Key Takeaways:
· CT 457 Plan Overview
· Why You Should Consider Conservative Investment Options
· Intermediate Core Bond vs. Intermediate Core-Plus Bond
· What is a Stable Value Fund?
· The Best Conservative Investments Within the 457 Plan
· Rollover into an Individual Retirement Account (IRA)
CT 457 Plan Overview
Unlike the other offered plans, the CT 457 plan is available to any employee or individual performing services for the State either by appointment or election. The 2023 contribution limit is $22,500 with an additional $7,500 catch-up clause for individuals 50 years of age or older. The advantage of this plan is that you can take withdrawals without penalty before you are 59 and a half years old. To contrast, the other three retirement plans offered by the State either prohibit premature distributions or leave you subject to a 10% penalty. Therefore, I would recommend that anyone eligible for the 457 plan should open an account.
Why You Should Consider Conservative Investment Options
There are several reasons to invest in conservative investments. A few examples are that you are risk averse in nature, have a short investment horizon, or fear the future economic outlook. All of these would result in the individual wanting to limit risk when available. For some, this would include investing their whole portfolio in conservative investments. I have seen this before, such as individuals putting their entire retirement portfolio into a fixed annuity to remove any market risk. However, most people will use a mixture of bonds (conservative) and aggressive (equities) to create a portfolio that maximizes their risk-return based on their preferences.
A common portfolio allocation for those in or approaching retirement is 60/40. What this means is that 60% of their portfolio is invested into equities, and 40% is invested into fixed income products which we are focusing on in this blog. The fixed income portion of a portfolio typically includes stable value funds, money market funds, fixed-income securities, and cash or cash equivalents. The purpose of these funds is to produce a predictable return with limited to no risk.
Intermediate Core Bond vs. Intermediate Core-Plus Bond
Now that we understand what is considered a conservative investment, let’s decipher between a Core Bond and Core-Plus Bond portfolios. This is important because both options can be found on the list of CT 457 plan investment options. Morningstar, a popular investment research firm, wrote an article in 2019 about the difference between the two types of bonds. You can follow this link to the article, but I will explain in my own words as well.
A Core Bond portfolio is composed of U.S fixed income issues, including government, corporate, and securitized debt which are all highly rated issues. The core bond holdings usually have less than 5% of the portfolio invested in issues below investment grade. If you did not know, bonds are ranked on the credit quality of the issuer. Bonds below investment grade are typically seen as riskier investments, so they pay higher rates of interest to compensate for the increased risk of default. Therefore, the Core Bond portfolio is going to be conservative as at least 95% of their holdings will be in investment grade issues.
To contrast, the Core-Plus Bond portfolio has more flexibility in their core holdings. The portfolio still holds investment grade bonds but has the option to hold riskier positions as well. These portfolios typically include high yield, bank loans, emerging-markets debt, and non-U.S. currency exposures. As discussed above, these positions are non-investment grade and will pay a larger amount of interest to make up for the increased risk of default. For this reason, the Core-Plus Bond portfolio will generally provide better investment performance in years of growth where all issuers can cover their obligations. However, if the economy was contracting then it could cause the Core Bond portfolio to outperform as it has less default risk.
What is a Stable Value Fund?
A stable value fund is composed of several low-risk bonds. They are like the Core Bond portfolio discussed above as the underlying securities are comparable, but the main difference is that the bonds in a stable value fund are insured. An insurance company or bank is contracted to protect the fund’s investors from loss of capital or interest which makes stable value funds suitable for conservative investors. No matter the market environment or state of the economy, a stable value fund will protect you from downside risk. Therefore, if we experience a recession in the future, the holders of stable value funds will find that portion of their portfolio to hold constant.
However, this protection does not come without drawbacks. First, stable value funds typically have high fees and lower yields. Historically, stable value funds have outperformed money market funds (a current popular investment) as they can invest in longer date, higher-yielding bonds. Although, during a period of high interest rates (like right now) the money market funds are paying over 4% interest net of fees while stable value funds pay less than 1% net of fees. If I had to invest in one right now, then I would choose a money market fund. Although retirement plans usually have a stable value fund rather than a money market fund. If you have a taxable account, or an IRA then you could opt for a money market fund to take advantage of the higher yields and lower fees (as of 6/7/2023).
The Best Conservative Investments Within the 457 Plan
The first conservative investment that I would recommend within the CT 457 Plan is the Connecticut Stable Value Fund. The average annual returns have held up over 2.3% over the past 10 years. In 2023, the fund has provided 0.59% in interest (as of 3/31/202) with an annualized rate of 2.52%. The drawback of this fund is that it does have a high expense ratio of 0.62% which will reduce your return. However, as discussed above, these bonds are insured so on top of the yield, the principal investment cannot be lost. This creates a great hedge against significant potential drawdowns like you could see during a recession.
The other conservative investments that I would recommend are dependent on your risk tolerance. Remember, both investments are already conservative (low risk), but one still carries more risk than the other. These positions would be the Intermediate Core Bond portfolio VBTIX or the Intermediate Core-Plus portfolio CBDIX. We have seen inflation begin to decrease significantly which means that we can assume interest rates will be cut sometime in the next 12 months. When interest rates (yields) go down, the price of bonds increase as they have an inverse relationship. Therefore, long-term investors can begin to position themselves for this move.
Now let’s review how these positions should fit into your portfolio. I mentioned that a common portfolio allocation for those approaching or in retirement is 60% equities and 40% fixed income. If you were to use this allocation, a simple strategy would be to invest 20% of your portfolio into the Stable Value fund, and the other 20% into VBTIX or CBDIX depending on your risk tolerance. The Stable Value investment will not go down so no matter what happens, 20% of your portfolio would be safe.
The other 20% invested in one of the two bond funds I listed will provide yield and could increase or decrease in value. That said, the largest drawdown for these bond funds are likely behind us. When the Fed increased interest rates at a record pace, bond funds saw poor performance as yields increased so bond prices decreased. As we stand, there could stand to be a few more rate increases, but we are likely near the top. For this reason, the potential downside for these bond funds is limited which makes it a great time to start a long-term positions. Interest rates were held near 0% for the past 10 years, so if we get anywhere close to that again then these bond funds should experience a significant amount of appreciation.
Rollover into an Individual Retirement Account (IRA)
The final thing that I want to mention is the benefit of rolling over your 457 plan when eligible. The Connecticut 457 plan has solid investment options, but the list is restricted. The plan does not allow you to purchase individual stock positons, commodities, emerging market funds, etc. The solution ito this issue is a rollover into an IRA that does not have restricted investment options which will allow you to create a portfolio that best suits your profile.
Unfortunately, you must meet specific criteria to rollover your account. There are two main reasons, either you have separated from State employment or you are older than age 59 and a half. If you are eligible, the first step you need to do is open an IRA with a trustworthy custodian. Then you can simple fill out the rollover paperword and the rest should be taken care of. If you are interest in rolling over your CT State 457 plan or would like to further discuss the conservative investment options then I’d recommend you schedule a consultation. You can sign up for my free consultation using the link. During the call, we can determine whether your needs match my expertise.
If you are interested in reading related blogs, then I would recommend:
“The Best Aggressive Investment Options in the CT State 457 Plan”
“What Connecticut State Employees Should Do With Extra Vacation Days”
“How to Calculate the Cost of Living Adjustment for CT State Employees”
