Anew kind of mutual fund is becoming popular among long-term investors. Known by various names, including life-cycle funds, lifestyle funds, life-strategy funds, and target-date or target-retirement funds, these funds eliminate physician-investors' need to periodically adjust the levels of stocks, bonds, and cash in their portfolios.
New York Times
According to a report, life-cycle funds offer investors an automatic way to shift money among asset classes, especially after a market shakeup or as investors' financial goals change. Data from the Financial Research Corporation of Boston indicate that there are at least 55 life-cycle funds on the market today.
Mutual Fund Choices
If you are saving only for retirement, life-cycle funds can be a convenient way to achieve a proper, diversified asset mix through a single investment. There are 2 types of life-cycle funds. The first type of life-cycle fund is designed to carry an investor from one stage of life to another. These funds maintain a fairly static asset mix and reflect a conservative, moderate, or aggressive level of risk. They resemble either a balanced fund (usually 60% equities and 40% bonds) or an asset allocation fund.
Suppose you start out with an aggressive fund. As you get older, you may wish to sell those shares and invest in a more conservative fund. You can make these changes fairly easily with a tax-deferred retirement account. If you have a regular account, however, switching funds could result in owing capital gains taxes. In this case, the second type of life-cycle fund, a retirement-date fund, is a better choice.
These funds radically adjust their asset mixes over time, growing more conservative as an investor nears retirement by switching a large portion of the portfolio from stocks to fixed income and cash. Retirement-date funds are for investors who plan to retire about 5 years before or after a certain year, the article notes. The year is often included in the fund's name.
The Fidelity Freedom 2010 is one such fund. This fund currently holds 45.4% of its assets in domestic and international stocks, 45.7% in high-yield and investment-grade bonds, and 9.1% in cash. By 2010, however, the fund's manager will have reduced the stock portion to 26%, the bond portion to 42%, and increased the cash holdings to 32%.
By 2015, the fund will be 20% in stocks, 40% in bonds, and 40% in cash. The fund will eventually merge with an income-only fund.
Pros and Cons
Life-cycle funds maintain proper asset allocation over time, making them an attractive investment vehicle. In addition, they usually cost less overall than multiple individual funds. Life-cycle funds have an average expense ratio of 1.26% assets. According to Morningstar, the average mutual fund has an expense ratio of 1.41%. Despite these advantages, life-cycle funds have their share of flaws.
While they tend to decline less than traditional balanced funds during market downturns, they typically do not outperform the market in good times. Owning life-cycle funds in tandem with other investments can distort the mix of assets in your portfolio. Take an inventory of your investment goals to determine whether or not life-cycle funds make sense for you.