Lifecycle funds are becoming popular, but some think their use is limited.
Investing doesn't get any easier than lifecycle
funds, at least on paper. The basic concept is enticing-invest in a
fund with a predetermined asset allocation based on your desired risk
tolerance or expected retirement date, sit back, and let the fund
managers make the appropriate allocation decisions for you. No fuss, no
Considering the appeal of prepackaged asset allocation, it's little wonder that lifecycle funds are one of the hottest areas in the mutual fund industry. According to Lipper, assets in this category have more than doubled since 2000, fueled in large part by their growing popularity among 401(k) providers. Fifty-five fund companies offered lifecycle products as of the end of last year, including such heavyweights as Fidelity Investments, The Vanguard Group and T. Rowe Price.
These investment vehicles go by a gaggle of names, such as lifecycle, lifestyle, target-date, target-risk, target-retirement and target-allocation funds. Lifecycle is the general catchall term, however. Despite their growing popularity, lifecycle funds aren't right for everyone, and that includes financial advisors. "Some advisors like them and some don't," says Eric Tashlein, a certified financial planner and principal at Connecticut Capital Management Group in Milford, Conn. "I guess I fall somewhere in-between."
Many advisors like the turnkey approach of lifestyle funds because it gives them time to focus on other areas of their practice beyond managing investments. But other advisors question their costs and the "commoditization" effect they have on the profession.
Lifecycle funds come in two flavors: those with portfolios built around specific retirement dates, and those built around specific asset allocations. Although some lifecycle portfolios are comprised of individual securities, the majority are fund of funds spread across various equity, fixed-income and money market assets.
Funds based on specific allocations are called target-risk or lifestyle funds. These run the gamut from conservative to moderate to aggressive portfolios, and they enable people to invest based on their risk profile at a given point in their life. According to conventional wisdom, a 25-year-old person should invest in an aggressive portfolio that's top-heavy in equities. Because target-risk funds essentially maintain the same allocation mix over time, that same investor should rotate into a less-aggressive fund when they reach middle age. Older investors, or the very risk-averse, should stick with conservative allocation mixes with greater fixed-income bents.
Financial Research Corp. in Boston reports that target-risk funds control more than 65% of total lifecycle fund assets. But target-date funds, or those with portfolio mixes pegged to specific retirement dates, are the faster-growing segment, thanks to their proliferation in the 401(k) market.
Target-date funds carry self-explanatory names such as the Barclays Global Investors 2010 fund or the Principal Investors Lifetime 2020 fund or the Wells Fargo Outlook 2040 fund, with the years indicating specific retirement dates. The further out the date, the greater the equity mix. These funds automatically rebalance their portfolios toward more conservative allocations as they go through time and draw closer to their specified retirement year. Beyond that point, many eventually convert into fixed-income-oriented funds designed to last another 20 to 30 years.
Different fund companies employ different allocation mixes within the same target date. The Vanguard Target Retirement 2035 portfolio is 77% invested in stocks, according to Morningstar. In comparison, stocks comprise 82% of the Fidelity Advisor Freedom 2035 fund and 89% of the T. Rowe Price Retirement 2035 fund.
T. Rowe Price's lifecycle funds are among the industry's most aggressive. The company's philosophy stems from extensive math modeling and studies of such factors as withdrawal rates, time horizons and various asset allocation mixes between equities, fixed income and cash, in 5% increments.
"We concluded that the biggest risk to investors is outliving their assets," says Jerome Clark, portfolio manager of T. Rowe Price's retirement funds. "Investors need an opportunity for enough capital appreciation to combat inflation and maintain purchasing power."
The company's M.O. is evident in their target-date funds, both before and after they reach their target maturity date. Most other fund companies combine their lifecycle funds with an income fund five to ten years after the target date is reached. T. Rowe Price favors keeping investors in their original fund for 30 years after the retirement year is reached, eventually whittling down their equity portion from 55% to 20% toward the end.
The professionally managed autopilot approach to lifecycle funds is finding a home among defined contribution plans, where horror stories abound about self-directed individuals butchering their retirement portfolios through lack of knowledge and poor decisions. A 2003 survey by Hewitt Associates found that 55% of plan sponsors offered lifecycle funds in their 401(k) plans versus 35% in 2001. Roughly one-third were in target-date funds.
With their asset-in-a-box approach, lifecycle funds are meant to be stand-alone investments. Too much diversification outside of these funds can muddy up the allocation picture for some investors. "There can be a lot of redundancy that screws up the appropriate allocation mix for their age," says Ross Frankenfield, an analyst with Financial Research.
But if properly managed, lifecycle funds can provide a degree of diversification that most small retirement accounts couldn't get otherwise. "I think they're great for novice investors because it gives them a disciplined approach that covers the broader market," says Tashlein from Connecticut Capital Management, who as part of his overall practice advises a handful of companies on their employee 401(k) plans. "I review a number of 401(k)s from individuals who chased after hot funds and ultimately would've been better off with the happy-meal approach."
Tashlein limits his use of lifestyle funds for these 401(k) clients, as well as for his private clients with 529 plans that generally comprise just a small portion of their overall holdings. Some plans, such as the American Funds, have age-based lifecycle features that change allocations as the child approaches college age. "Rather than me spending a lot of time reallocating this small account," he says, "this fund does it automatically."
But Tashlein cautions that some investors get a false sense of security from these funds. "Some of these portfolios tanked 40% or more during the downturn, so they're certainly not a sure thing," he says.
Gauging lifecycle fund performance isn't easy, partly because most haven't been around very long and also because they have varying allocation strategies that make comparisons difficult. "The best way to gauge lifecycle funds is to analyze the underlying fund of funds and compare those that are style- or sector-specific against their peer groups," says Lipper analyst Lucas Garland.
That might be doable for a Vanguard fund with just a few underlying index funds, but try doing that with a Fidelity Freedom fund comprised of up to 18 underlying Fidelity funds. Given the diversity of funds underpinning many lifecycle offerings, some become so broadly allocated that they essentially become index funds that more or less track the market. For some advisors, that doesn't justify the cost of these offerings.
"I'll pay for management when it brings value," says Michael Scarborough, president of The Scarborough Group in Annapolis, Md. "I'm not going to pay for management of index funds when I can use iShares."
Lifecycle fund fees can vary. Investors pay the pro rata fees associated with the underlying funds, which isn't a huge bite if it's with a low-cost fund company. But some companies charge an additional fee for management and other expenses associated with the actual lifecycle fund, and fees tacked onto advisor-class shares bump up costs even more. Meanwhile, frequent portfolio rebalancing can rack up capital gains distributions unless the funds are in tax-advantaged accounts.
Scarborough, whose firm provides actively-managed 401(k) accounts for individual investors, says he adds value for his clients by creating lifecycle-type accounts at less cost than those provided by mutual fund companies. "What's happening is that the big fund companies are turning everyone in my industry into a commodity," he says. "Everything is boiling down to a price point. You have to know how to manage money, not just how to sell something."
The flood of new products probably won't abate any time soon. More than 80 new lifecycle funds were introduced last year, bringing the total to 244 as of year-end 2004. Fidelity is the category leader, with 30 lifecycle funds and total assets of $33 billion as of February. The fund giant has a whopping 70% market share in the target-date category, and is slightly trailing Vanguard's 18% market leadership in the target-risk segment.
Fidelity, T. Rowe Price and others are stepping up marketing efforts through the advisory channel, and that's fine for some advisors. "I feel liberated by lifecycle funds," says Mark Ferris, a certified financial planner at Yankee Cents Financial Services in Old Saybrook, Conn.
Ferris says he used to be the de facto lifecycle fund manager for his clients, but now puts many of his clients into target-risk portfolios from among either the Gartmore Optimal Allocation or J.P. Morgan Investor funds, or in target-date funds from Fidelity. "Using these funds allows people in our profession to focus on financial issues with clients, beyond the stock market," says Ferris.