Lifecycle Funds and Your Asset Allocation

I’ve been getting some great comments and questions on my blog, and much of the recent activity has been focused on retirement matters.

The timing of these questions couldn’t be better since I am busy putting together a new blockbuster report that covers the entire range of retirement topics. [Editor's note: For all the details on Nilus' new retirement report, and to secure your copy, click here. ]

For example, one reader asked me about a 401(k) plan that is invested in a so-called “lifecycle” fund.

These mutual funds — which also go by names like “targeted funds” or “age-based” funds — have been gaining prominence in employer retirement plans in recent years.

Reason: They take care of asset allocation for you.

Today, I want to tell you about some concerns I have with these funds. But first, let’s talk more about the basic principle of asset allocation.

Determining What Should Be In Your Retirement Portfolio …

As far as most investors are concerned, there are really only three basic investment categories — stocks, bonds, and cash equivalents. Commodities, currencies, and a few other “alternative assets” round out the bigger list.

Yet even with just these few choices, it’s a challenge to figure out how much of your money should go to each.

One traditional rule of thumb says to subtract your age from 100. The resulting answer determines the percentage of stocks that should be in your portfolio.

For example, a 40-year-old investor would allocate 60% to equities.

The obvious idea here is that the longer you have until retirement, the more aggressive you can be with your portfolio. Since stocks are historically more volatile — but also better able to outpace inflation over long periods — they deserve the lion’s share of a younger investor’s nest egg.

Figuring out the right mix for your retirement portfolio is no easy task!

In contrast, bonds are considered better able to weather storms and kick off income, so they should comprise a higher percentage of an older investor’s portfolio.

Or at least that’s the traditional thinking.

As you know, I don’t necessarily agree that bonds trump stocks either as income investments or as safe havens.

But I do agree that older investors should move into more conservative assets as they get closer to — or into — retirement.

The recent stock market decline is proof why:

If you need to withdraw money on a regular basis from your account, you don’t want to be forced to do so when stocks just got a 50% haircut.

On the other hand, if you’re invested in solid income-producing investments, you’ll be able to live off the cash streams and leave the underlying assets to recover with the market.

Of course, age is just one factor in determining your asset allocation. Risk tolerance is another.

Some people — even 20-year-olds — just aren’t able to sleep at night when they’re sitting on paper losses of 40% or 50%.

And that’s fine. Those people might be better off in ultra-conservative investments. Sure, math and history might argue otherwise, but no amount of investment return is worth more than the ability to relax and enjoy life!

So my point is this …

While There Are Rough Guidelines, No Asset Allocation Is Right for an Entire Generation of Investors!

This is my first problem with the lifecycle funds — a fund manager cannot know what asset allocation is best for you. Let me explain …

Lifecycle funds are “fund of funds.” In other words, you buy one fund, but really own multiple mutual funds under that single banner.

The appeal is that you can simply decide when you plan on retiring, and let the lifecycle fund do the rest. The manager will automatically determine what kind of asset allocation is appropriate for you and then spread your money into funds that cover those areas.

Example: A 30-year-old investor might buy a lifecycle fund with a 2040 target date. And right now, that fund might put 70% into a couple of different stock mutual funds and the other 30% into some bond mutual funds.

Then, as the years go by, the manager will gradually make the portfolio more conservative, by shifting money from the stock funds into the bond funds.

End result: By the time 2040 rolls around, the lifecycle fund will be primarily invested in bond funds and our now-61-year-old investor is ready to enjoy retirement.

But as I just pointed out, what’s good for the goose might not be good for the gander! There’s no way to lump an entire generation into one asset allocation.

Moreover, even lifecycle funds with similar target dates can vary wildly in terms of their holdings.

Some managers are very conservative, even for far-off dates. Others might go hog wild on stocks.

There’s really no way to know without doing some due diligence. And at that point, you might as well just assemble a list of funds or individual investments that suit your needs!

The other little dirty secret about lifecycle funds is this: Perhaps their biggest design feature is that they lead to nice fees and commissions for the companies that run them.

In fact, the beauty of this approach — from a fund company’s perspective — is that it virtually guarantees all an investor’s assets stay “in house.” It doesn’t matter if the fees are high or the individual fund performances poor. The concept encourages you to mindlessly pour your money into the same firm … and keep it there as long as you live!

Am I saying all lifecycle funds are bad? Of course not.

You can find low-fee choices that might work well for you, especially if you don’t like picking individual investments or worrying about monitoring your asset allocation. (Just make sure you select an appropriate end date at the outset!)

Moreover, the concept of a single all-encompassing fund choice is a great way to get more people to start investing in their company retirement plans, and at least get some diversification in the process.

Hey, I’d much rather see someone invest in an imperfect vehicle than not plan for retirement at all!

But in my opinion, there are other ways to build simple, cost-effective, well-balanced retirement portfolios if you have the choice.

Best wishes,

Nilus

P.S. My favorite way to build a simple, cost-effective retirement portfolio is just one of the many things I talk about in my new retirement report — “The Weiss Guide to Worry-Free Retirement Profits.” I also show you 5 different ways to boost your Social Security payments … how to use various retirement accounts to shelter assets and rapidly build wealth … and talk about the latest changes coming out of Washington that will directly impact your golden years.

For all the details, and to secure your copy at a special pre-publication rate, click here right now.

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Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Michelle Johncke, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.

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