Life Cycle Funds

Life Cycle Fundsfrom_our_columnists

A One-Time Solution That Could Last a Lifetime

By Kara Stefan

kara_stefanMost people are afraid to get started investing because there’s potentially so much to know. There’s a lot of talk about market risk, but another risk is that of getting sucked down into the whirlpool of financial information from which there is no way out.

The key is to start small, with simple, manageable investments. Lots of people get their first taste through their company’s 401(k) plan. Here too, however, you must choose your underlying investments–usually a combination of mutual funds and maybe even your company’s stock.

Mutual Funds
Mutual funds are considered the easiest way for investors to step into the investing arena. These funds pool money from hundreds of individual investors, place it in the hands of a professional money manager who makes the day-to-day buy and sell decisions of individual securities.

Most mutual funds are well diversified, which means they hold many different investments so that the entire fund isn’t reliant on the performance of just a few companies. However, most mutual funds are segmented by asset classes–growth stocks, income-yielding bonds, international securities, etc. Some hold a combination of several different asset types, which are generally referred to as balanced funds.

Life Cycle Funds
Then there’s the easiest, most convenient type of fund of all–the life cycle fund. This, too, is a balanced fund. But what makes it unique is that the combination of assets changes as you grow older.

The basic premise behind life cycle funds is that investors tend to grow more conservative and risk averse as they grow older. This stands to reason, since as a young person, you have plenty of time for your investments to fail and then (hopefully) rebound. As you age, however, you want to maintain the interest you earned during your risk-taking days of youth.

A life cycle fund–also placed in the hands of a competent money manager–goes one step further. The money manager will change the percentages of asset classes represented in the fund according to your age group. The following gives you a general idea of how this works:

  • Stocks: high-risk investments; higher percentage when you’re in your 20s-40s.
  • Bonds: medium-risk investments; higher percentage as you approach and throughout retirement.
  • Cash instruments: low-risk, principal preservation investments; highest percentage held during retirement years.

“What life cycle funds do is automatically reallocate what you invest in, depending on your age,” says financial radio talk show host and author, Adriane Berg. She explains that when you first invest, you choose an allocation that matches your current age group–typically depicted as a pie chart with slices for each asset class. As you age, that allocation will change to meet the needs and expectations of you and all the other fund investors that fall into that age group.

Performance vs. Convenience
Berg says she has mixed feelings about life cycle funds where performance is concerned: “I think they tend to underperform, especially compared to investments where the money manager is a specialist in a particular category.”

“But on the pro side, they’re easy. If you’re not the kind of person who’s going to do your own asset allocating and change the mix as you grow older, life cycle funds can be a good choice.”

Who Should Invest?
Life cycle funds are ideal if you’re just starting out and don’t have a lot of money to invest. To achieve their brand of asset mix, you would generally have to invest in several different mutual funds, each carrying a potentially hefty required minimum investment. With a life cycle fund, you have exposure to a diverse selection of securities across various asset classes.

As for risk, Berg says life cycle funds are “light and have often been criticized for being very conservative in these go-go years.” You may end up sacrificing some of your potential return for the convenience of actively managed asset allocation, but this can be an ideal solution for the novice or risk-averse investor.

Many offer flexible allocation choices–so you may select an allocation that is more or less risky than what is recommended for your age group. In this case, the allocation will change according to the age group for which it is recommended–which may not suit you as you grow older.

When you invest, it’s a good idea to enroll in the fund’s automatic investment plan, so you can contribute a small amount to the fund each month that transfers directly from your bank account. This establishes a disciplined, lifelong investment habit, and monthly investments can help lower your overall cost per share.

Many banks offer life cycle funds, as they are generally a good choice for bank-oriented savers who are just getting started with investing. To compare what choices are out there, offers plenty of information on performance and risk.

Once you get started, investing won’t seem as overwhelming and intimidating as it might have before. The key is not to bite off more than you can chew–and digest. Fortunately, life cycle funds are an attractive option. And if you decide you just don’t want to delve further into the extensive world of investing, they’ll carry you straight through to your retirement years.