Are Lifecycle Funds Right for Your Retirement?


If picking four or five mutual funds from your 401(k) menu is more baffling than you care to admit, there’s another option designed to do most of the work for you.

The instrument in question is known as a lifecycle, or target-date, fund.

These mutual fund options base their asset allocation around a specific date—usually your expected retirement—and then rebalance (by buying and selling holdings) to create more conservative allocations as that date approaches. Hence, these investment choices are likely to have names like the “2030” fund or “2040” fund.

They are “balanced” funds, meaning that they will contain stock as well as bond investments, with a ratio that becomes less risky (and more fixed-income-focused) as you age.

So far, lifecycle funds have found the most favor with younger and newer plan participants. A new report from the Employee Benefit Research Institute and the Investment Company Institute finds that at the end of 2007, almost 19% of the 401(k) account balances of recently hired participants in their twenties were invested in lifecycle funds, compared with 16% at the end of 2006.

Phil Suess, who heads up the defined contribution plan investment consulting business for Mercer, Inc., the consulting firm, says that new employees that are introduced to a company 401(k) for the first time tend to choose lifecycle funds over other options partly because they are newer on the scene than many other sorts of mutual funds, including target-risk funds—another balanced approach wherein asset allocations are built around a pre-specified level of risk, such as conservative, moderate or aggressive.

Pioneers in the target-date fund category include Fidelity and Barclays Global Investors, a division of Barclays PLC (Stock Quote: BCS).

"Those looking at this for the first time are very comfortable outsourcing investment decisions versus making these decisions themselves," Suess says, adding that the current crop of target-date lifecycle funds actually make good sense for all 401(k) plan participants, given that so many of them aren't comfortable choosing their own investments from their employers' plan menu.

Costs Need Not Put You Off
A lifecycle fund that is based on indexed approaches, where managers attempt to replicate market indices such as S&P 500 (Stock Quote: ^GSPC), may charge as little as 20 to 25 basis points for investment management—in other words, .20% to .25% of the assets you invest,

Other lifecycle strategies may cost 60 to 80 basis points, says Suess, a level he calls “comparable to an actively-managed equity fund.”

Like most investments, lifecycle funds’ performance has been off lately. During the third quarter of 2008, the average target-date fund lost 10%—slightly more than the 8.4% loss for the S&P 500, says a report from the Boston-based Financial Research Corporation (FRC).

Participants who don’t reach for lifecycle funds as 401(k) options are usually just falling prey to inertia, however, says Suess. "Those who've been in the plan for an extended period of time often don't make any change unless they're forced to."

One promising development for lifecycle funds is that new federal rules under the Pension Protection Act of 2006 state that when employers offer 401(k) auto-enrollment and participants fail to make their own investment choices, the funds could be placed into lifecycle funds as one of the “default” investment choices. This move suggests more and more employers will offer a lifecycle fund going forward.


Lifecycle strategies vary widely between fund companies. When looking at 2020 funds, for instance, FRC found a wide range of equity allocations, with stock market exposures ranging from as low as 51% (which may seem low to some) to as high as 90% (which may feel like too much).

Given that the lifecycle fund approach is meant to be a one-fund solution housing several complementary strategies, and that participants should not be pairing lifecycle funds with other menu choices, a lot will be riding on a single, multifaceted strategy.

If you are in doubt about your employer’s lifecycle fund, don’t be shy: Simply ask the fund company for a list of its fund’s holdings and run them by an impartial financial professional.



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