New Mutual Funds Gain Growing Approval

Physician's Money Digest, December31 2003, Volume 10, Issue 24

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.

Times

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.

Another disadvantage:

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.