Lifecycle Funds: Cruise Control for Your Investing Strategy

A central investing principle states that your portfolio’s asset allocation should depend upon your time horizon, which is the length of time remaining until you will need to cash in your portfolio’s assets. But how exactly you distribute your money between stocks, bonds, and cash? And how do risk tolerance and time frame affect your portfolio over time? And what if you want to totally avoid the hassle of ongoing rebalancing for your individual stocks, bonds, and mutual funds?

Set It and Forget It
A lifecycle fund–sometimes called a target fund–attempts to tailor your investing strategy to your time frame for a particular goal, such as retirement.

Let’s say you plan to retire in 2040. You might choose a fund with a target maturity date of 2040. Between now and then, the fund will gradually shift its asset allocation between stocks, bonds, and cash. The closer the target date, the more conservatively (less stocks, more bonds) the fund would invest. A lifecycle fund with a target maturity date of 2040 would be likely to have a higher percentage of its assets in stocks than a fund targeted at 2010.

Advantages of Lifecycle Funds
Asset allocation is critical to your long-term returns, but if the idea of regularly rebalancing your retirement portfolio prompts an anxiety attack, then a lifecycle fund can help you simplify the process. The automatic asset allocation of a lifecycle fund may give you a better chance of achieving a long-term goal than if you tried to go it alone without investing experience or good financial advice. (Note: Diversification alone does not guarantee a profit or insure against a loss.)

Disadvantages of Lifecycle Funds
If you have other investments outside of the lifecycle fund, you may need help from a financial professional to achieve an appropriate overall asset allocation for your portfolio. Additionally, a lifecycle fund does not consider your individual financial situation, including tax concerns.

Don’t Be Fooled By Look-Alikes
Just because a lifecycle fund targets a particular time frame doesn’t mean your choice is a slam dunk. Even if they have the same target maturity date, lifecycle funds from various companies may have different approaches to achieving their goals. Most take a “fund of funds” approach, investing in an assortment of stock or bond funds from the same fund family. However, the number of funds used can vary widely.

An aggressive allocation for one portfolio with a 2040 target date may have a significantly greater percentage of stocks than another. Another important difference among funds is the way asset allocations are shifted over time, particularly after the target date has been reached. Some reach their most conservative allocation at the target date and then keep those percentages static. Others continue to become more conservative after the target date is reached.

You Can Do It!
With lifecycle funds, it’s particularly important to take a long-term perspective. You do not want to jump in and out of the fund in response to daily market changes. Lifecycle funds’ objectives are long-term, and your short-term selling typically undercuts the overall strategy.

Check your assumptions
Just because a lifecycle fund has a certain target date doesn’t mean it’s necessarily the right choice for you. People are living longer, and you may need a more aggressive allocation to provide a sufficient nest egg. A qualified financial professional can help you estimate your needs and gauge what strategy is most likely to work best for you.