Using "Lifecycle" Funds to Better Manage Your Investments

By: Jonathan D. Pond | Source: AARP.org | November 11, 2008

"Lifecycle funds" are attracting significant investor attention and money—for good reason. These funds allow you to invest your money, even in small amounts, in a single fund with self-stabilizing features, including:

• Diversifies across several important investment categories
• Holds mutual funds with solid performance histories or individual stocks and bonds that are actively managed
• Regularly rebalances your holdings
  

Rebalancing involves the fund manager making small adjustments to the various investments so the fund arrives at the desired (target) percentages. For example, if the percentage of stocks should sink below the target due to a declining stock market, the manager would rebalance the overall portfolio to get back to the allocation target by buying more stocks and selling bonds or cash.

While buying stocks in a declining stock market may seem dangerous, periodic rebalancing rarely involves big investment shifts. Plus, adding to stocks after they've declined and vice versa has proved time and time again to be an excellent investment strategy.

Many mutual fund families have introduced a stable of lifecycle funds. They are becoming particularly popular among those who participate in workplace retirement plans (such as 401(k)s and 403(b)s) and tax-sheltered annuities (TSAs). Any investor can own these funds either in a retirement plan or in a brokerage account.

The main attraction of target or lifestyle funds is the investor's ability to choose a single, all-purpose fund instead of having to pick from among a long list of investment choices. Most lifecycle funds range from pretty good to excellent, but you need to evaluate them just like any other investment.
If you don't want to be bothered with investing, they're a wonderful solution. But if you're into investing, you also might want to consider lifecycle funds. If you're frightened by today's turbulent market conditions, use lifecycle funds to invest conservatively while still maintaining a well-diversified portfolio of stocks and interest-earning securities.

 There are two different kinds of lifecycle funds:

• Lifestyle funds. These are the older siblings of lifecycle funds and consist of funds that take a different and pretty consistent approach to way the money in the fund is invested. Lifestyle funds are usually offered as a series of mutual funds and are usually labeled "conservative," "income," "balanced," "growth," and "aggressive." Each individual fund is managed against a particular mix of stocks, bonds, and cash. For example, a "growth" fund would hold a much higher percentage of stocks than a "conservative" fund, which would be heavily invested in bonds. Most lifestyle funds hold individual securities.
• Target funds.  Target funds are designed to take the mystery out of age-based investment diversification. All you need to do is to estimate your retirement date, select a target fund near the date, and the mutual fund company will gradually change the allocation over the years. Target funds are easy to identify, because they have the target dates in their names: 2015, 2025, 2035, for example. These "funds of funds" typically hold several different stock and bond funds within a single fund family in various proportions to suit investors, depending on their specific stages in life. For example a young person with decades to invest can afford to do so with more risk, while a pre-retiree invests a bit more conservatively, and a person who has already retired needs to receive certain investment income. 

You get more for your money with lifestyle and target funds, but the even better news is you probably won't have to pay a lot more. Most fund companies levy very small additional fees for these funds on top of the usual fees associated with the individual mutual funds. But check on the extra fees, because some companies do charge a hefty amount for their lifestyle and target funds.

Strategies for Investing in Scary Markets

Lifestyle funds and target funds are tailored for coping with turbulent investment markets. You can use lifestyle and target funds if you want to invest a bit more conservatively. They would help in a scenario in which you were more comfortable owning fewer stocks without haphazardly selling off individual investment holdings.

• Lifestyle Funds. The trick with lifestyle funds is to move from the fund you hold to one that is more conservatively invested. For example, if you hold a "moderate" lifestyle fund but want to lower your stock exposure, move all or part of your holding in the moderate fund into a "conservative" fund. If you are new to lifestyle funds, you might initially buy a fund that is one notch below the kind of fund you would own amidst more healthy investment markets. If you fancy yourself an aggressive investor but are afraid that the stock market will continue to suffer, you might initially opt for a "moderate" fund.
• Target Funds. If you're stunned by the amount of money you have lost during the stock market meltdown, you can also use target funds to establish a lower-risk investment mix. If you already own a target fund, simply move into a fund that has a shorter target date. Depending on the date you choose, you will reduce your stock exposure either a little or very much. For example, moving from a 2025 fund to a 2015 fund will reduce stock exposure by 21 percent while still maintaining a diversified investment portfolio. If you are new to target funds and want to be more conservative now than you would if the investment markets were more fruitful, simply pick a target date closer to your desired retirement age. So if you were planning to retire around 2025, rather than opting for a 2025 target fund, choose instead a 2020 or 2015 fund for lower stock exposure.

The flexibility that lifecycle funds offer works for both long- and short-term investors: If and when you want to invest a higher proportion of your money in stocks, move your money into a target fund with a later date. For example, if you changed the retirement date from 2025 to 2035, your fund would have a higher percentage of stocks and be a more aggressive investment.

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