Independent Investor: Set It and Forget It
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Life-cycle funds, sometimes called target–date or age-based funds, offer investors a simple path through the complexity of investing. All you need do is make two decisions.
The first is easy: pick your retirement date. Most life-cycle funds are targeted and identified by a specific retirement year, like the 2050 fund or 2020 fund. Next, pick your risk-tolerance level. Are you a conservative, moderate or aggressive investor? That's it; the fund takes care of the rest.
Life-cycle funds got started after studies revealed that many investors do a poor job diversifying and rebalancing their portfolios as they approach retirement. So Wall Street stepped in with a maintenance-free alternative to the do-it-yourself approach.
Normally, these funds are structured with an aggressive mix of bonds and stocks in the early years. The fund mangers determine how much to invest in cash, bonds, stocks and where (domestic versus international) based on your risk-tolerance level. As the fund and you grow older the investment mix grows progressively more conservative until your retirement date.
Let's take my friend Scott, for example. He is 40 years old, with a moderate risk tolerance (which means he is willing to take some risks to see his retirement fund grow but he's not going to bet the farm on it) and plans to retire in 2033.
He selects a fund close to his retirement target. We'll call it "Fund 2035" offered in three categories: aggressive, moderate and conservative. The fund's present investment allocation for a moderate investor is 60 percent stocks, 30 percent bonds and 10 percent cash.
The portfolio is also designed to rebalance and reallocate continuously all the time, as Scott grows older. Fast forward 10 years, the portfolio allocation has changed. It is now 55 percent stocks, 35 percent bonds and 10 percent cash. By the year 2035, the allocation may be invested mostly in bonds and cash with just a small proportion in equity. Of course, the old trade-off between risk and return still applies. The more conservative (less risk) the fund incurs the less return one can expect.
There's more. Let's say stocks perform really well next year. By the end of 2008 they have grown from 60 percent to 70 percent of the portfolio while bonds and cash have slipped lower. The fund manger will automatically rebalance, selling stocks and buying bonds until the portfolio is back to its proper allocation. If you decide at some point that you want to adjust your risk-level higher or lower you can always do that by simply switching to another fund.
Assets under management have almost tripled over the past few years. All the big boys like Fidelity, Schwab, Vanguard, etc. offer these age-based funds so it is a good idea to shop around since there may be a big difference in the fees one fund charges over another.
A few caveats are in order as well. This is one investment where you should "put all your eggs in one basket" since you are hiring a life-cycle fund to diversify your money so you don’t have to do it.
One draw back to purchasing a life-cycle fund from a family of funds is that the manager will limit his selection of funds to only his company's offerings, which may not be the optimal choice.
Since the fund is set on autopilot; as you grow older, more of your money will be invested in bonds. That poses its own risks. What if, for example, the world enters a ten-year bear market in bonds as you turn 55 or inflation returns to double digits as it did back in the late 70s?
So maybe you do have to pay some attention to long-term economic trends, but my take is that life-cycle funds are both sensible and simple and offer peace of mind to the retail investor bewildered by the number of investment options today.
Bill Schmick is a licensed investment adviser representative and portfolio strategist with Berkshire-based Dion Money Management, managing more than $800 million for middle class Americans from coast to coast. Direct your inquires to Bill at 1-877-850-7942, Ext. 146 (toll free) or e-mail him at wschmick@dionmm.com. You can also visit www.afewdollarsmore.com for more of Bill's insight.
