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Life-Cycle Funds

Life-Cycle Funds

The investment product that’s the latest rage among investors (except for those still chasing high-risk, high-fee hedge funds) is the life-cycle fund. Life-cycle funds are mutual funds that invest in other mutual funds. They are a “black box” approach – a one-size-fits-all default.

They’re the kind of investment where investors “set it and forget it” (with apologies to Ron Popeil, his rotisserie oven and its wonderful slogan…by the way, who is eating 9 quarter-pound hamburgers anyway? We’ve got to stop watching those mesmerizing infomercials!)

Retail investors are familiar with some of the more popular funds.

Indeed, two of the largest mutual fund complexes have an entire family of them. Fidelity offers the Freedom Funds and Vanguard offers the STAR and Target Retirement series of funds. Investors who participate in their company’s savings plans are familiar with the “conservative allocation”, “moderate allocation” and “aggressive allocation”.

Let’s take a look at how these funds operate. Some funds assume that investors with a similar retirement date will have similar objectives and a similar risk profile. Of course how many of us know when we will retire or are truly in touch with how risk averse we are?

As a result of these “similar objectives”, some funds will change their asset allocation over time. To be frank, it’s a bit unnerving to make changes along the way. What happens when management decides to increase exposure to an asset class such as junk bonds? They may feel it’s the right move for investors with “similar objectives” but what about the “conservative” or “moderate” investor who would never dream of owning junk bonds? Is it truly the right time for a shift away from a pre-determined strategy or is management chasing returns by adding another layer of risk?

Other funds automatically rebalance to meet an allocation mandate.

These static allocations require the investor to decide when he or she is no longer “aggressive”, “moderate” or “conservative” in his or her risk outlook.

The nice thing about life-cycle funds is that they are ultra-diversified.

However, does this mean that an investor is all but guaranteeing middle of the road performance? And what of the investor who adds a life-cycle fund to an already diversified portfolio? He or she ends up with an asset allocation fund buried within his or her portfolio which, by definition, already had a settled upon asset allocation.

The real trouble with life-cycle funds is not with the funds themselves but with the investors who invest in them. Life-cycle funds are an off-the-rack item when most of us require a custom tailor. Are these funds right for us? More importantly, are we right for these funds? Do we really know what we want from our investments? Are life-cycle funds the “right” vehicle for achieving our goals? Hopefully investors will take a good hard look at themselves before they drown in the sea of press currently being lavished on this latest of investment fads.

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