Target-Date and Lifecycle Funds

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Autopilot Investing as You Soar Toward Retirement

Isn’t it interesting all the things that need adjusting as the years roll by? Waistbands, eyeglass prescriptions, even the TV volume ... I said, EVEN THE TV VOLUME! But one thing you don’t need to fiddle with is a target-date fund (sometimes called a lifecycle fund) if you have one in your retirement plan portfolio.

Target-date funds offer an array of stocks, bonds and cash equivalents, and the percentage in each asset class adjusts on a regular basis, based on the investor’s targeted retirement year. So, for example, someone who plans to retire in 2035 would choose a target-date fund with that target date. The asset mix will start out more heavily weighted in equities, then gradually shift toward a more conservative allocation as retirement draws near. This "glide path" adjusts the percentage of equities, fixed income and other investments as the fund matures, but different funds can have different objectives. The glide path is managed by the mutual fund company offering the fund.

Lifecycle funds are similar to target-date funds in that you can choose an asset mix based on your retirement date, but some lifecycle funds combine a time horizon plus risk level and some are based only on risk. If you are a conservative investor with 30 years until retirement and choose a fund based simply on risk, you take a chance that the fund will be invested too conservatively to meet your retirement goals. In addition, you may need to make a conscious choice to move from a higher-risk lifecycle fund to a lower-risk one as you near retirement. Regardless of the date and/or risk level provided by the fund, it's important to read the prospectus and understand the funds' objectives, asset allocation and major holdings.

Because they are diversified in their mix of asset classes as well as investments within those classes, in some cases target-date and lifecycle funds may be considered a total portfolio. They have grown in popularity since their introduction in the early 1990s, especially in employer-sponsored retirement plans such as 403(b)s. The primary reason is that many investors have neither the time nor the expertise to monitor the asset allocation of their portfolios. So a fund that is “programmed” to adjust its allocation automatically may be an attractive option.

It's important to note that some target-date funds have come under fire for high fees, so be sure to determine what the fees are before investing.

Be Aware of the Differences

There are some drawbacks to investing in target-date funds that should be considered:

  • One-size-fits-all asset mixes. Not everyone of similar age shares the same financial needs, which can vary depending on factors such as number of dependents and what other assets an investor owns, as well as individual risk tolerances.
  • Inconsistent asset allocation mixes. Even funds with identical target dates have different asset allocations and underlying investments. According to The Washington Post (Jan. 18, 2009), losses on 2010 target-date funds in 2008 ranged from 3.6% to 41% (past performance is not an indication of future results).
  • Difficult to track performance. Because target-date funds shift not only their investments but their asset allocations, their past performance may have even less relevance to how they will do in the future compared to other types of funds. Your best bet may be to compare them against other target-date or lifecycle funds with the same target dates, or against the Dow Jones Target Date Indexes *

Making It Work for You

To make the most of a target-date or lifecycle fund, consider these suggestions:

  • Select a target-date fund that best matches your needs for income and growth, your risk tolerance and your targeted retirement date. Consider one that maintains a percentage in equities even after you retire as a hedge against inflation. Given that if you retire at 60, you can expect to live well in excess of 20 years in retirement, you should consider an asset allocation that still maintains a medium to long term time horizon at your retirement date, unless you have a very low risk tolerance threshold. You can compare funds at www.403bCompare.com.
  • Remember that it is a long-term investment. Trying to time the market by switching funds could increase fees and cause you to miss out on upturns in your investments.
  • Compare fees. Check out the funds available in your plan and compare the fees in the prospectuses at www.403bCompare.com. According to SmartMoney, the average target-date fund has an annual expense ratio of 1.22% (compared with 1.37% for the average diversified U.S. stock fund), but you might want to aim for an expense ratio of less than 1%. In some cases, better performance justifies a higher expense ratio, but for many long-term investors, a low expense ratio may produce better results.

Sample Target Date Allocations

Each target-date or lifecycle fund will have its own allocation, but here are a few typical examples:
Target retirement date 2040: 90% stocks, 10% fixed income
Target retirement date 2030: 84% stocks, 16% fixed income
Target retirement date 2015: 61% stocks, 39% fixed income

 

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