Peace-of-Mind Portfolios

Life-cycle funds shift your asset mix as you age

Life-cycle funds, which offer investors pre-mixed portfolios of stocks, bonds, and cash according to their age, have been around for about a decade. The diversified approach they take is a smart way to save for retirement, but you'll rarely hear a financial planner or broker recommend them. "They wouldn't be good for business," confides Dee Lee, a Boston financial planner and co-author of The Complete Idiot's Guide to Retiring Early (Alpha Press, $19.95).

Why? These mutual funds make practically all the investment decisions for you. They're designed to get you from an aggressive stock-heavy portfolio to a more conservative investment mix the closer you get to retiring. Once you retire, they're also a handy way to stay invested partially in stocks while drawing a steady income from bonds and cash.

At a time when the stock market is sagging, the strategy of these funds looks wise. Over the past five years through June 30, the typical life-cycle fund has gained an annualized 4.20%, vs. 3.89% for the average stock fund, according to investment-research firm Morningstar. This year, life-cycle funds are off 6.42%, but that's a better showing than the 11.70% loss racked up by the average stock fund.

Life-cycle funds operate in one of two ways. The first type is a fund with a targeted retirement date. If you invest in Fidelity Freedom 2030, for example, 84% of your money will currently be in large-, medium-, and small-company stocks, including nearly 9% in international equities. Over the next 28 years, the mix will move toward more bonds and cash.

The second and more common life-cycle investment is a series of funds with preset asset allocations. It's not as hands-off as the first type: You must move the money from one fund to another, perhaps once a decade, to ensure that you have the right portfolio for your age. An example: Vanguard's LifeStrategy series, with funds that go from growth to moderate growth to conservative growth and finally, income.

Although Charles Schwab and other fund supermarkets offer life-cycle funds to individuals, 401(k) plans are their biggest market. But Lori Lucas, a defined-contribution consultant at employee-benefits firm Hewitt Associates, says many workers don't use them properly. They put equal amounts in a life-cycle fund, a bond fund, a money market fund, and maybe a stock fund, so all told, they're overloaded with fixed-income investments.

You should use a life-cycle fund as a core holding and add other funds to diversify your overall portfolio. For instance, Vanguard's LifeStrategy Growth keeps only 5.9% of assets in small-company stocks. So if you owned that fund, you might also want to buy a small-cap fund. Fidelity Freedom 2000 (for people who are about to retire, or just did) keeps 27% of its assets in assorted large-, medium-, and small-cap stocks. But financial planner Lee advises that retirees hold closer to 40% of their investments in equities. In that case, you might also want to own a broad stock fund, such as one that invests in the Wilshire 5000 stock index.

Many life-cycle funds are "funds of funds," comprised of various stock and bond funds. That means you really have to watch for fees. Franklin Templeton Conservative Target A, for instance, charges an annual expense ratio of 0.54%, calculated from the 12 individual funds it holds, as well as its own 0.92% on top of that. An exception: With Vanguard, you pay for the underlying funds, but there's no fee for managing the mix.

A life-cycle fund will never be the hottest fund of the year. But with hot funds, you have to know when to sell. With life-cycle funds, you can just hold them right into retirement.

By Susan Scherreik

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