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How Lifecycle funds ease investing angst

Set-it-and-forget-it mutual funds adjust automatically

By Michael S. Falk, CFA

When you think of retirement investing, does the thought of doing research, making choices and monitoring your progress give you a headache?

If you're like most people, the answer is yes.

In response, mutual-fund companies have created "lifecycle" funds to ease our headache. While lifecycle funds do most of the investing work on our behalf and significantly reduce the number of choices, investors still must choose and use them wisely.

To help you decide whether a lifecycle fund is right for you, you should review the five basic steps to successful investing.

1.   Asset allocation. How much of your savings should be invested in stocks, bonds or cash? That depends on how much and when you will need to begin spending your invested savings.

2.   Asset diversification. For example, how much of the stock allocation should be in large companies vs. small companies? Domestic vs. foreign?

3.   Asset management. Do you want to buy, sell or hold stocks yourself or invest in a stock mutual fund that does it for you?

The final two steps ensure that over time your investments still fit your situation.

4.   Rebalance. If the performance of one of your stock funds is much better than your other investments, then your overall mix will overweight that fund. For instance, tech stocks peaked in 2000, and bottomed in late 2002. An investor who rode the boom up and failed to rebalance by late 2002 might have lost up to two-thirds of his tech portfolio from the peak.

The investor could have remedied this over-weighting by selling enough of the winning fund and investing the proceeds among his other investments to return to his initial allocation.

5.   Reassess. Your needs and goals change, so you should reassess your asset allocation to make sure it is still right for you.

Most of us are "reluctant investors" -- a phrase coined by ProManage to describe people who lack the time, desire or knowledge to invest for themselves.

Reluctant investors can hire a professional adviser, use a managed account in their 401(k) plan or use a lifecycle fund.

Lifecycle funds -- funds investing in other funds -- are only as good as the underlying funds they are invested in.

They have a variety of names, but only two basic types: risk-based and target-retirement-date funds. The key to success with either type is to use only one.

Risk-based funds -- typically described as conservative, moderate and aggressive -- focus on fixed-asset allocations. For example, the moderate fund might invest 60 percent in stocks and 40 percent in bonds. This approach puts the first four basic steps to successful investing on auto pilot, requiring you to select a new fund when and if your needs or goals change.

Target-retirement-date funds often are identified by the ending target date, such as a "2020 fund" if you expect to retire in 2020. These funds put all five steps on auto pilot, gradually reducing the allocation to stocks as the fund's target date approaches. The reason for the gradual reduction is to reduce the risk of losses the closer you get to spending all or a part of your savings.

While target-retirement-date funds are primarily designed to assist in retirement investing, they can be used for college savings as well. For example, if your child is four years old today, he or she will enter college in 14 years, and so a 2020 fund could make sense.

Don't put too much confidence in the names, however. A review of all lifecycle funds with roughly 60 percent invested in stocks yields names ranging from "Moderate Growth" to "Personal Strategy Balanced" to "2010" and "2020."

Evaluating the stock allocations of several popular Target retirement-date funds shows: People under the age of 40 (25 years away from retirement) are no less than 80 percent invested in stocks; 50-year-olds (15 years away) are roughly 70 percent invested in stocks; 60-year-olds (five years away) are roughly 50 percent invested, and retirees have anywhere from 20 to 40 percent invested in stocks.

In selecting the right target-retirement-date fund, what's most important is not your present age. What's important is to determine when you will begin spending some of your invested savings.

Since target-retirement-date funds typically invest in other mutual funds offered by the same mutual-fund company, you should avoid those that charge extra for their packaging. Access to an adviser, if available, might be helpful in selecting the best target retirement-date fund for you, but be wary of fees tied to your savings.

Overall, lifecycle funds can be a valuable investment tool when they are selected and used properly. As they relate to reluctant investors, lifecycle funds allow them to pursue the better things in life.

 

Michael S. Falk, vice president and chief investment officer of ProManage LLC, Chicago, is a chartered financial analyst. He is an adjunct professor at DePaul University and speaks on behalf of the CFA Society of Chicago. He can be reached at
mfalk@promanageplan.com.

WHAT IS A LIFECYCLE FUND?

These offerings from mutual funds typically are funds of funds that gradually adjust their mix of stocks, bonds and cash to become more conservative as they approach an investor's retirement date. The idea is to provide a one-stop, set-it-and-forget-it portfolio that helps investors in areas in which they are often weakest: asset allocation and periodic rebalancing of their portfolios.

While most lifecycle funds are targeted at an investor's retirement date, they can be timed for college expenses and other situations for which the investor must have sufficient cash available.