5 Reasons Why Not to Like Lifecycle Funds

Regulators and legislators in the U.S. currently have lifecycle funds under the microscope and may be making changes to address some irregularities that have come to light.

Lifecycle funds (LCFs), also known as target-date funds (TDFs), are basically packages of equity and bond mutual funds that shift toward the bond funds as the investor approaches a retirement date. The idea is to put the asset allocation decision on cruise control, to automatically shift toward more conservative investments as the investor ages – as classic asset allocation theory prescribes.

It’s now becoming more apparent that asset mixes in LCFs can vary from provider to provider, and be rather aggressive in some cases. In the U.S., for example, it was found that 2010 target-date funds (one year to retirement) had allocations to equities ranging from 8% to 68% and those at the high end of this range experienced huge drops of 40% or more in 2008. If someone is a year away from retiring, they shouldn’t be loosing 40% of their wealth, so something seems amiss here — hence the recent scrutiny by politicians and regulators.

I never was a fan of lifecycle funds anyways. For the following reasons:

1. Asset mixes: they shouldn’t be based just on one’s age but include other factors (that may change over time), such as size of nest egg, personal health, type of job, etc.

2. Inflexibility: one’s preferred retirement date may change from the date selected in a LCF and/or one may want to delay the phasing out of equities when in a bear market, like now

3. High fees: mutual-fund management fees in Canada average around 2.4% annually — and then there will be another fee on top of this for the “wrap” portion of the LCF

4. Other investments: asset mixes in LCFs are usually designed as if the holder had no other assets; but if they do have other investments, an annuity or a pension, the LCF mix may be inappropriate

5. Opaqueness: it sometimes is not easy to see what’s inside – i.e. asset mix and/or cost; it’s hard to compare LCFs from one to another

While we might avoid LCFs, we should not eschew the benefit of shifting toward more conservative assets as we age. And this is easy to do with a diversified basket of low-cost index funds or exchange-traded funds based on concepts like the Couch Potato Portfolio.

All it takes is a commitment to spend a few minutes a year to rebalance the portfolio. Don’t let inertia or bull markets take you off the path — don’t be like one in four U.S. investors approaching retirement age (56-65) in 2007. On the eve of the bear market, they had more than 70% in stocks, according to the Center for Retirement Research at Boston College.

Comments

[Adam855:]

I think that the concept is not necessarily a bad one. The problems are more in the area of implementation. Like you implied, no fund with a retirement target of 2010 should have a high equity mix. I'd say that given the choice of a properly constructed LCF vs. no thought given toward asset mix at all (since many either have no idea where to even start, or put no effort into it), go with the LCF.
The reality is though that the responsibility always ends up in the lap of the owner of the portfolio. The Madoff escapade reminded everyone that even seemingly trusted and skilled financial advisors must be examined. Two phrases come to mind: "trust but verify", and "there's no such thing as a free lunch".

Jul 10 12:04 AM