In the spirit of being a contrarian anda skeptic, let me discuss two productsthat are now being marketed vigorously:individually managed accounts andlife-cycle funds. Although the two are differentproducts, investors are attracted tothem for the same reason. They want toturn over most of the investment decisionmaking to professionals. But once youpeer beneath the surface, neither productis particularly attractive.
Managed Accounts Woes
Financial institutions offer individuallymanaged accounts under differentnames. When you open an account youhand over a good size portfolio and pickone or more investment managers fromthe company's recommended list. Theywill, supposedly, design and manage aportfolio to match your needs andpredilections. In addition, the buyingand selling in the portfolio can be tailoredto match your tax situation.
In principle, individually managedaccounts sound attractive. In fact, this ishow the very rich have been investingtheir money for decades. So, why shouldn'tyou jump in? First, it is essentiallyimpossible to design a well-diversifiedportfolio of individual stocks and bondsfor a portfolio of $100,000 or even$500,000. This is exactly where mutualfunds shine. You can achieve solid diversificationfor as little as $1000.
Second, the costs of individually managedaccounts are likely to be very high—usually in the range of 2% per year—especiallyfor small portfolios. Here again, wellselected index funds and low-expense, no-loadmutual funds offer a definite edgebecause you can keep your costs wellbelow 1% per year fairly easily.
Third, although the selling point forthese accounts is often the past performanceof a manager, you can rarelymake a sound judgment about that performancebased on the limited data youreceive. What's more, you probablywon't receive a lot of attention from amoney manager or an individualizedportfolio unless your portfolio is fairlylarge. If you don't have a large portfolioand know how to evaluate investmentperformance, you're better off investingin a portfolio of traditional mutual andexchange-traded funds.
Life Cycle Constraints
Life cycle funds, a cousin of balancedfunds, are offered by most large mutualfund companies. Like balanced funds,they hold more than one class of assets.Unlike balanced funds, the proportionsof the different classes of assets are graduallyadjusted over time to reduce risk.These adjustments are made mechanicallyand based on a set formula.
While you avoid the hassles of assetallocation by investing in a life-cyclefund, you give up too much flexibility forlittle benefit. You can't choose whatstock and bond funds your money isinvested in, control the rate at whichyour asset allocation is adjusted, or controlhow much of your stocks vs bondsare sold when you sell. While I'm all forlaziness in investing, this is taking it to anextreme with no compelling benefit.
Chandan Sengupta is the authorof The Only Proven Road toInvestment Success (John Wiley;2001) and Financial ModelingUsing Excel and VBA (John Wiley;2004). He teaches finance (ie,investment, business valuation, etc) at the FordhamUniversity Graduate School of Business and alsoconsults with individuals on financial planning andinvestment management. He welcomes questionsand comments at firstname.lastname@example.org.