[ Here’s what you need to know about life-cycle funds:
Understanding Life-Cycle Funds
Life-cycle funds are specialized asset-allocation funds designed to lower risk as you approach your desired retirement date. They automatically adjust the share of different asset classes, typically increasing the percentage of bonds and other fixed-income investments. This strategic adjustment aims to provide a balanced risk-reward ratio, making them perfect for people planning for retirement. Depending on your retirement horizon, you’ll choose a life-cycle fund targeting that specific retirement year.
For instance, a young investor saving for retirement might opt for a life-cycle fund with a target date 30 to 40 years in the future. Conversely, an investor nearing retirement may prefer a fund with a target date less than two decades away if they plan to continue working partially after retirement. This strategic approach helps manage higher volatility to better stretch retirement funds over the expected 20+ years of post-retirement life.
How Life-Cycle Funds Operate
Life-cycle funds are designed with fixed investment goals that require capital at specific future dates. Though mainly used for retirement planning, these funds are also versatile for any capital needs timed for the future. Each fund’s time horizon is defined by its named target date.
Imagine you invest in a life-cycle fund targeting a 2050 retirement date. Starting in 2020, the fund would likely be aggressive, with 80% in stocks and 20% in bonds. Over time, it gradually shifts its allocation, reducing stocks and increasing bonds. By 2035, halfway to retirement, it could be split 60% stocks and 40% bonds, reaching 40% stocks and 60% bonds by 2050. This transition minimizes risk as your retirement date approaches.
Why You Should Consider Life-Cycle Funds
The main attraction of life-cycle funds is their convenience for investors who need capital at a specific date, like retirement. Investing becomes almost automatic once you select the appropriate fund. The funds’ preset asset allocations offer confidence and transparency, gradually reducing high-risk investments over time.
A major advantage is the preset glide path that provides clear visibility on the fund’s strategy and assures you of a managed reduction in risk leading up to the target date. These funds combine simplicity and intelligent asset management, making them ideal for passive investors focusing on long-term goals.
Common Criticisms of Life-Cycle Funds
Though life-cycle funds are generally seen as a reliable investment method, they have some critics. Opponents argue that rigid, age-based approaches might not always consider market conditions like bull markets. Market legends like Benjamin Graham have advised adjusting investments based on stock and bond market conditions rather than age. Echoing his thoughts, economist Robert Shiller noted the importance of considering market valuations using methods such as the P/E 10 ratio.
The assumption that young investors can always handle more risk is another criticism. Many young investors have relatively little savings and experience, making them vulnerable, especially during economic downturns. They might end up selling stocks at inopportune times due to market volatility.
Also, more proactive investors might find life-cycle funds too passive and might instead opt for financial advisors or other active management strategies.
KEY TAKEAWAYS
- Life-cycle funds adjust asset allocations automatically to reduce risk as the target retirement date nears.
- Ideal for investors with precise capital needs timed for the future, commonly used for retirement planning.
- Well-suited for passive, long-term investors seeking managed, transparent portfolios.
- Criticized for a rigid approach that doesn’t adjust for market conditions or the nuanced needs of young investors.
Example of a Life-Cycle Fund
Consider the Vanguard Target Retirement 2065 Trust. Launched in July 2017, it’s an exemplary illustration of how life-cycle funds manage risk over time. Initially, the fund maintains a 90% equity and 10% bond allocation for the first 20 years. Gradually, it shifts more towards bonds, aiming for a 50/40/10 split of equities, bonds, and short-term TIPS by the year 2065. Post-target-date, it further transitions to a stable 30% stocks, 50% bonds, and 20% short-term TIPS.
Related Terms: target date funds, retirement funds, investment portfolio, asset classes, glide path.
References
- Vanguard. “Target Retirement 2065 Trust I”.
