Look into life-stage funds
NEW YORK – Automatic payroll deductions have made saving for the future easier than ever, but for millions of Americans who participate in employer-sponsored retirement plans, figuring out how to divvy up those investment dollars remains a mystery.
Faced with a bewildering array of mutual funds, workers with 401(k) and other tax-deferred savings accounts often make poor choices when it comes to asset allocation, which experts say is one of the most important concepts of money management and financial planning. To help simplify this process, fund companies are churning out a growing number of “life-stage” products that automatically divide your money into blocks of stock, bonds and cash, appropriate for your age or tolerance for risk.
The idea is to provide one-stop shopping for investors who lack the time, inclination or knowledge to manage their own assets on an ongoing basis – and that’s more than half of us, according to a study conducted earlier this year by John Hancock Financial Services. People are so poorly educated and disengaged when it comes to investing, the survey found, very few are on track to save the 75 percent of preretirement income typically thought to be needed to maintain their lifestyle once they stop working.
If you haven’t yet run across one of these life-stage, or “hybrid” funds, chances are you will soon. They are now offered by 55 percent of large company 401(k) plans, up from just 35 percent in 2001.
Best of all, experts say, they work. A follow-up study conducted by Manulife USA, the parent company of John Hancock, found that 401(k) participants who contributed to a life-stage fund between 1999 and 2003 earned better returns than those who selected their own investments.
Life-stage funds come in two flavors: the somewhat older “life-style” funds maintain a predetermined allocation based on risk tolerance; the newer “life-cycle” funds automatically rebalance over time, according to the investor’s retirement date.
Life-style funds, which emerged in the 1990s, generally identify a risk level in their name, such as “moderate allocation” or “conservative allocation.” In theory, younger investors with longer time horizons would start out with a fund of moderate risk, and at some point would decide to move to a more conservative allocation. The problem, experts say, is that investors often fail to make this change; in fact, the John Hancock survey found nearly half of investors never make any changes at all to their contributions or asset allocations once they’ve started a retirement plan.
The newer life-cycle funds, also known as “target maturity funds,” aim to fix that by automatically adjusting the balance of stocks and bonds to more conservative levels as time passes. These funds usually identify an expected retirement date in their name; for example, a 25-year-old who expects to retire in 40 years might invest in a “Target 2045” fund. Initially the stock and bond mix would be quite aggressive – perhaps 90 percent stock and 10 percent bonds. But over many years, the equity portion would scale down, and by the target date, the fund would hold a far more conservative allocation — about 35 percent in stocks, 55 percent in bonds and 10 percent in cash, on average.