Life cycle investing
NEW YORK – Life cycle funds that are becoming increasingly popular are meant to make retirement planning easy. But that’s not how investors have been using them, mutual fund companies say.
The funds are aimed at a specific retirement year. Fidelity Investments’ life cycle Freedom Funds for instance, start with a fund for people who retired before 1998, then progress to a fund for people who plan to retire in 2050.
The funds are an aggregation of many other mutual funds, sometimes as many as 25. The idea behind life cycle funds is that investors tend to do a poor job of diversifying and rebalancing their portfolios as they approach retirement, so the fund will do it for you, starting with an aggressive mix of equities and bonds in the decades before retirement and rebalancing, often daily, to maintain diversification.
The funds become more conservative as retirement nears, selling stocks and buying bonds; they’re meant to be an all-in-one solution for retirement, offering complete diversification in a single fund.
The problem, according a study from The Vanguard Group Inc., “How America Saves 2005,” is that while the funds offer complete diversification in one investment vehicle, “actual participant behavior is at odds with this goal, with many participants using life cycle funds as just another part of their overall portfolio.”
The larger problem is that people continue to do really foolish things with the rest of their portfolios. Vanguard found in its study that 13 percent of participants in its defined contribution funds had their entire accounts in fixed-income securities and 21 percent held all-equity portfolios. Forty-four percent of participants in plans that offered company stocks held concentrated holdings exceeding 20 percent of their account balances. The big idea behind life cycle funds is that they are one way to save investors from themselves.
But that doesn’t appear to be happening. Vanguard found that 29 percent of people who invested in the funds as part of their company’s retirement benefits used the funds as intended, as an all-in-one investment. Another 49 percent invested in a life cycle fund and one or more stock funds.
The third group of life cycle fund investors appears to take what Vanguard calls “a naive approach,” investing in multiple life cycle funds. In 2004, 22 percent of Vanguard participants with access to life cycle funds owned multiple life cycle funds and some also invested in other funds, too.
Fidelity’s advice for investors in life cycle funds is to invest the bulk of their assets in a fund targeted for their retirement group, then use the small portion left to play with.
If you’re reading this, you may be sophisticated enough as an investor that you don’t need the simplicity of a life cycle fund. But if you know anyone who is making any of the classic mistakes – too much company stock, buying only stock funds, or putting everything into an asset class that has already peaked – the idea of putting almost everything in a life cycle fund, then playing around with the change may be a simple solution that makes sense.