Lifecycle funds – also known as “target-date funds” – are an option for retirement planners that doesn’t require regular upkeep. By reducing risk as you get closer to your goal, lifecycle funds increasingly focus on preserving capital than boosting capital appreciation. These funds have become popular recently because of their “set-it-and-forget-it” investment approach. In this article, we’ll share what they are, how they work and the pros and cons you should consider before adopting this investment style. If you want help with lifecycle funds or any other financial questions, consider working with a financial advisor.
What Are Lifecycle Funds?
Lifecycle funds are diversified investment products that adjust their risk profile based on your investment timeframe. These funds are also commonly referred to as “target-date funds” and “aged-based funds.” They are designed to reach capital goals in a specific timeframe, and investors often use lifecycle funds when saving for retirement, college or other goals.
How Lifecycle Funds Work
Some investors prefer lifecycle funds because they are a simple, one-stop solution to diversification and risk management. The investor chooses a timeframe for their investments and the lifecycle fund invests their money to a predetermined portfolio allocation. The investments tend to start out more aggressive, then become more conservative as the target date approaches.
For example, a 30-year old employee enrolls in a 401(k) plan. They are unsure of which investment options to pick, so they choose the target date fund for age 65. With 35 years to the target date, the portfolio mix will start aggressively weighted towards stocks since they have time to ride out short-term fluctuations in value.
As the employee ages, the portfolio mix will become less aggressive and more conservative. This often includes adding more bonds and income-focused investments versus those focusing on pure growth.
When the employee reaches their target date of 65, the portfolio will be heavily weighted towards income-producing assets with a small mix of stocks for continued growth.
Throughout the investment timeframe, the lifecycle fund rebalances whenever an investment strays too far from the preferred mix. Plus, it reallocates investments towards the predetermined portfolio mix when specific time-based milestones are attained.
Pros and Cons of Lifecycle Funds
Whether a lifecycle fund is right for you depends on your timeline, risk profile and financial goals. Arriving at a decision about this kind of fund means considering the pros and cons of these products.
- Hands-off investing. Investors don’t have to worry about fund selection or other portfolio maintenance tasks.
- Age-appropriate risk tolerance. The funds automatically adjust the investments risk profile based on your time horizon for needing the money.
- Pre-set path to retirement. Investors don’t have to guess how their money will be allocated in the future. The plan documents provide the predetermined asset allocations ahead of time.
- Default investment option for companies. Many companies choose target-date funds as the default option for company retirement plans. This is a drastic improvement over the previous default option of a money market or stable value fund.
- One-size-fits-all strategy. Your risk tolerance and investment goals are unique, so why do your investments use a cookie-cutter approach? Everyone who chooses that target date will receive the same investment allocation.
- No choice in investments. Investors have many choices for the investments, however, lifecycle funds use only a handful. Other investments targeting the same niche may offer better returns, lower expenses or other benefits than what are in the lifecycle fund.
- May be too conservative. Many lifecycle funds become too conservative too soon for many investors. While you may plan to retire at age 65, you may only need a fraction of the money at that time. Many retirees need a higher percentage of stocks than a lifecycle fund may be using to counter inflation and longevity risks.
- Risk profile may be too high for young investors. Young investors who are just starting out may not be comfortable with aggressive investing and volatility. This is especially true in a downturn when their investments could drop while simultaneously being at a higher risk of losing their job.
How to Choose a Lifecycle Fund
When evaluating lifecycle funds, most investors choose the fund that closely matches their target date for retirement, college, or other goals. But that’s not the only factor that you should pay attention to when comparing these investment options.
- Target date and goal date. Target date funds typically have five-year increments between investment options. Your goals may not perfectly align to these dates. Depending on your risk tolerance, you may choose the later date (higher risk) or earlier date (more conservative).
- Glide path design. The current allocation isn’t the only allocation that you need to pay attention to. Review the investment’s document to understand its glide path. Are you comfortable with how the fund allocates assets between now and the target date? Is it too aggressive or conservative for you?
- Target date allocation. When the lifecycle fund reaches its target date, how are the funds allocated? Some investors think that the ending allocation is too conservative, while others believe that it’s too aggressive.
- Fees and expenses. How much does the lifecycle fund charge for their services? Any fees that they charge are in addition to the expenses charged by the mutual or exchange-traded funds that it invests in on your behalf.
The Bottom Line
Lifecycle funds can be a valuable part of your investment strategy. Remember that you are not committed to your choices. It is OK for a specific lifecycle fund to be a good fit today, but not tomorrow. As your goals or strategy changes, your current investments may no longer work and it is appropriate to update them. Working with an advisor can help you determine the appropriate investment strategy for every stage in life.
Asset Allocation Tips
- Allocating your investments to your investment style is a wise choice. Many investors are unsure of how they should allocate their portfolios. Our asset allocation calculator helps you create an investment mix that matches your comfort with risk and timeframe for investing.
- Even with available tools, many investors are unsure about which investments to choose. That’s where a financial advisor can make a big difference. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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