Lifecycle funds: taking a balanced approach to saving

Mutual funds follow fashion. Twenty years ago the cult of the great stockpicker (in the style of Fidelity’s Peter Lynch) was all the rage. Next came the no-load index fund era in which Vanguard dominated, and in the late 1990s, Janus’s heavily concentrated technology funds were the “it” investment.

The latest trend in mutual fund investing is lifecycle funds. These are all-in-one plans that reduce stock exposure as you near a particular retirement date. In many ways they complete mutual funds’ own cycle, returning to their origin as products designed to be the only investment investors would ever need.

The principle behind these investments is simple: the longer your time horizon before retirement, the larger the percentage of your portfolio that should be invested in equities. The shorter your time horizon, the more your portfolio should be invested in safer havens, namely bonds and cash.

You can make these adjustments on your own but many investors find that lifecycle funds – also known as target asset-allocation funds or age-based funds – are an easy alternative.

Money has flooded into lifecycle funds over the past few years. According to official figures, they held $8bn in assets in 2000; now they hold more than $70bn.

“We all lead busy lives and the ability to hand over decisions about asset allocation to a professional is appealing,” says Sarah Holden, an economist at the Investment Company Institute, who said the funds were a response to consumer demand. “The most positive aspect about these funds is that they rebalance for you once a year over time with a goal.”

As the end retirement date nears, lifecycle funds, which are typically funds of funds, become income funds, geared toward creating cash dividends more than growth of principal. For example, Vanguard’s Target Retirement 2045 has 89 per cent of its assets in stocks and 11 per cent in bonds. Vanguard’s Target Retirement 2010 fund, by contrast, has 47 per cent in stocks and 53 per cent in bonds.

Fidelity’s lifecycle accounts, branded as Freedom Funds, follow an asset allocation strategy that becomes increasingly conservative until it reaches 20 per cent in domestic equity funds, 35 per cent in investment grade fixed-income funds, 5 per cent in high yield fixed-income funds, and 40 per cent in short-term funds approximately 10 to 15 years after the specified retirement date.

Avi Nachmany, director of asset management research company Strategic Insight, says the lifecycle investment trend has staying power. “This is not temporary, this is no marketing gimmick,” he says.

“This is a dimension of an investment solution based on asset allocation that is reshaping the way mutual funds are bought and sold in this country.”

Some experts, however, are wary of this simplified approach to retirement investing. Risk tolerance varies from investor to investor and a one-size-fits-all approach does not take into account individuals’ different needs. And experts say that if the target retirement date of your fund – the nearest fund to your retirement year – is a few years away, it could have a dramatic impact your savings plan.

In addition, some in the industry criticise the funds’ narrow selection. They tend to invest heavily in large domestic growth stocks with very little allocated to international funds, value stocks, and small companies.

In spite of these flaws, Mr Nachmany says lifecycle funds are good bets for both mutual fund providers and individual investors. “The lifecycle solution makes sense for the company because they are selling a greater stability of assets, not exaggerated expectations,” he says.

“Too often investors left on their own are too passive, too lazy, too ignorant or too greedy and so they make bad choices,” he adds. “With these funds investors know they are doing the right thing rather than just buying the stock of the month.”