Does Your Lifestyle Demand A Lifestyle Fund?

Whether you're juggling a hodgepodge of investments or just trying to decide among the offerings in your 401(k) plan, structuring a coherent portfolio can be a burdensome task--especially in today's volatile markets where it's easy to doubt your every move. But the mutual-fund industry has come up with a seemingly simple solution: so-called lifestyle funds. These are portfolios of stocks, bonds, and cash crafted for investors with a specific investment horizon and risk tolerance. You just choose one and let professional managers maintain their ideal mix of assets, making small shifts in response to the economic outlook, interest rates, and the financial markets.

"The industry is offering what it should have sold all along--an actively managed product targeted toward a time line," says Geoffrey Bobroff, of Bobroff Consulting Inc. in East Greenwich, R.I. Too few investors assess risk based on how much time they have until they need the money, he says.

Essentially, lifestyle funds are just permutations of asset allocation funds. They offer simplicity and diversification, which can appeal to time-strapped baby boomers.

But some serious skepticism is in order here. Many of the lifestyle funds are new, with no established track record. Because of their eclectic mix of investment classes, they are hard to compare with other funds. And their performance recently leaves a lot to be desired. Many were humbled this year when bonds failed to provide insulation from stock market declines.

Investors willing to put in a little more time can create a portfolio tailored more precisely to their needs than this kind of one-stop shopping can provide. And, even if you are the kind of hands-off investor these funds were made for, by the time you choose among all the new offerings, investing by life stage may not seem so simple.

It's no surprise that the fund industry has been aggressively pushing the funds these days--selling funds based on performance is tough when almost all sectors of the market are down. Fund companies have found that they can use people's fears of being in the wrong place at the wrong time as a selling tool. "People need the diversification in periods of uncertainty," says Stephen Gibson, Putnam Investments' mutual-fund marketing director.

RIGHT MIX. The number of asset-allocation mutual funds has doubled in the last two years to more than 100--and many more are on the way. Putnam was among the leaders when it launched three "Lifestage" funds (growth, balanced, and conservative) last March. Wells Fargo expanded its Stagecoach line to include five "LifePath" portfolios that actually change their strategy over time--becoming more conservative as the investor approaches retirement or some other goal. A new family, Countdown to Retirement Funds, of Naperville, Ill., works on the same principle. It offers two portfolios that will be largely income-producing by the year 2010 or 2020.

This fall, Vanguard will expand its STAR asset allocation fund, composed of a mix of Vanguard funds, into four "Life Strategy" portfolios--an income and a conservative, moderate, and regular growth version. Scudder, which offers three Managed Retirement Trusts for 401(k) plans, has just begun the lengthy application process to offer such multifund funds directly to individuals. T. Rowe Price is bringing out three "Personal Strategy" funds made up of individual securities.

Whether the company differentiates among its funds by risk tolerance (conservative or growth), by investment strategy (income or growth), or by the year you will start needing the money, the key factor to consider is the target asset mix. There is quite a bit of variety. For example, among two 401(k) offerings, BT Investment Lifecycle Long Range Fund aims for a mix of 55% stocks, 35% bonds, and 10% money markets, while IDS Horizon Fund's Long-Term Portfolio is 95% stocks and 5% bonds. Among the best-known fund groups, T. Rowe Price's Personal Strategy Income Fund is 40% stocks, 40% bonds, and 20% cash, while Fidelity Asset Manager Income is 20% stocks, 30% bonds, and 50% cash. The breakdowns fluctuate based on market conditions.

But with lifestyle funds, "you could end up really having the wrong kind of asset allocation for your needs," says Amy Arnott, an analyst with Morningstar Inc. If you choose a fund too heavily weighted with fixed-income investments, you might not build up enough capital over time. Or you could end up taking more risk than you can handle and panicking over loss of principal.

But the target mix won't tell you everything. You also have to look at the management style and the underlying securities that can be included in the portfolios. Two veterans in this category illustrate disparate approaches: Vanguard Asset Allocation Fund sticks with domestic securities, using all treasuries and stocks from the Standard & Poor's 500-stock index. Fidelity Asset Manager can employ riskier foreign and small-capitalization stocks, high-yield bonds, and derivatives.

These funds rely heavily on computer models to devise the right asset mix, but then may use active or passive strategies to select the securities. The new Stagecoach LifePath Funds are run primarily off a model that allocates assets among different indexes. Putnam's Lifestage Funds have one money manager to decide the asset allocation and an investment committee made up of eight fund managers to pick individual securities from their areas of expertise.

According to Tracey Curvey, Fidelity Investments' vice-president of retail marketing for asset allocation products: "You need to diversify across managers" as well as across asset classes.

Although analyzing track records of lifestyle funds isn't easy, you can get some data on the multifund funds by looking at the past performance of the underlying offerings. For the ones run by committee, you can see how the funds the members manage have fared.

WAY OUT. Keep in mind that these funds have not been performing that well this year: The group as a whole was down 3.04% through July 22. Owning a mix of assets reduces market volatility over time. "But in a bear market caused by the threat of inflation and higher interest rates, bonds won't protect you," says Jay Schabacker, editor of the newsletter Mutual Fund Investing (301 424-3700).

One way out of that dilemma is going overseas. Arnott says that including international securities in your portfolio is a good bet. A study by Massachusetts Financial Services, before it launched the MFS World Asset Allocation Fund, found you could earn the same returns as a diversified domestic fund with 25% less risk by adding international stocks and bonds.

Finally, you should consider available alternatives to lifestyle funds that lack some of their disadvantages, such as "balanced" funds, which usually maintain a constant mix of 60% stocks, 40% fixed-income, and no cash. Balanced funds are relatively easy to compare with one another, and many have excellent track records. And if you want to have a large component of your portfolio in cash, you can simply keep it separate and enjoy the liquidity of money-market funds.

Still, if lifestyle funds hold true to their promise, they could work well as the core of your portfolio. You can add either more aggressive or conservative funds for investment goals with different time horizons, or, as Schabacker recommends, "take a more eclectic approach" during bear markets when neither stocks nor bonds are faring well. Even the most sophisticated investors will enjoy the simplified tax reporting you get when small asset-allocation shifts are made from inside a fund rather than by buying and selling individual securities.

Lifestyle funds will never be No. 1 in the rankings, but for people who are currently investing too conservatively or without a sensible strategy, that's not what matters. At least the new funds can take some of the guesswork out of organizing your portfolio.

      Fund                           Investment policy
      PUTNAM                  One manager determines asset allocation. Then,
      LIFESTAGE               eight fund managers choose securities from
      GROWTH,                 their areas of expertise. New in March, the funds
      BALANCED,               each own eight asset classes. Balanced port-
      CONSERVATIVE            folio mix: 65% equities, 35% fixed-income.
      STAGECOACH              These funds, introduced in March, become
      LIFEPATH                more conservative as the investor approaches
      2000, 2010, 2020,       retirement or some other goal. (The funds are
      2030, 2040.             named for the year you'll need the money.) The manager
                              decides asset allocation, but uses index funds for the
                              underlying investments. The 2020 portfolio is now 65%
                              equities, 35% fixed-income.
      T. ROWE PRICE           These three new funds come with a Personal
      PERSONAL                Strategy Planner to help people define their
      STRATEGY                goals. Unlike T. Rowe Price's Spectrum funds,
      INCOME, BALANCED,       which are made up of different mutual
      GROWTH                  funds, these are actively managed. Target mix for the
                              growth fund: 80% stocks, 20% bonds.
      VANGUARD LIFE           Available this fall, offerings are constructed
      STRATEGY                from 10 Vanguard mutual funds: seven equity,
      INCOME AND              two fixed-income, and a money-market fund.
      THREE GROWTH            The target for the moderate growth option is
                              60% equities and 40% bonds.
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