|
Building and maintaining a retirement
portfolio isn't easy. Mutual fund profiles can be daunting. Assessing your retirement
needs is a time-consuming exercise. And, once established, portfolios need ongoing
tending.
That's a big reason why the lifestyle fund
— whether called by that name or referred to as a profile fund or life cycle fund
— is coming into fashion. Plan sponsors and participants are looking for someone else
to take the "driver's seat" in retirement plan investments and education.
Lifestyle funds are all-in-one investment options for
individuals who lack the time or inclination to worry about asset allocation in their
retirement plan. These prepackaged funds — each of which contains multiple mutual
funds — maintain a mix of stock, bond and money market funds targeted to meet the
needs of investors at a given age and/or risk tolerance.
In 1999, more than 20 percent of 401(k) plans offered this
type of fund as an investment option, according to the Profit Sharing/401(k) Council of
America.
How They Work
There are two basic types of lifestyle funds. One type lets
investors choose a fund based on their risk profile; choices might include aggressive,
growth, balanced, moderate, and conservative. An aggressive portfolio would consist almost
entirely of equity funds, with a healthy portion of small-cap and international equities
included. A conservative profile would be invested almost entirely in bond and money
market funds, although it might also include some large-cap funds. The notion is that as
your risk profile changes over time, you'll switch your retirement money into a more
appropriate fund.
 |
| Why Is Asset Allocation Important? |
The reason asset allocation is so important
to your portfolio, say financial experts, is that you can create a portfolio that gives
you the best potential return for a given risk level. If you plot many of these portfolios
in a graph, you get a line called the efficient frontier. While small investors have had
access to extensive information over the Internet for some time, not until recently have
they had access to online professional investment advice that helps them approach the
efficient frontier. For more about this, see Wall Street 101.
|
|
|
The second type of lifestyle fund — often referred to
as a "life cycle fund" — is based on a target retirement date. Rather than
focusing on the investor's desired level of risk, these funds presume a certain level of
risk based on the time left until retirement. Funds with later target dates — that
is, those for younger workers — invest very aggressively. As the investor gets closer
to retirement age, the fund reallocates into more conservative investments. This way, an
investor can keep a single fund continuously throughout his or her career rather than
switching out of and into funds as his or her risk tolerance changes.
For example, the State of Alaska 401(a) plan's "Target
Series" contains five Target funds with retirement dates in 2000 (end of year), 2005,
2010, 2015 and 2020. Each fund has a unique asset allocation that becomes more
conservative as the target year nears. The 2005 fund is scheduled to be 100 percent in
cash by the end of the year 2005, while the 2020 fund is scheduled to still be invested
with 90 percent in stock funds and 10 percent in bond funds at that time.
Are You Using Them Correctly?
A nice benefit of profile funds is that they not only
handle asset allocation but they also rebalance the portfolio regularly. This keeps the
portfolio in line with the desired asset allocation; because as some investments gain or
lose value relative to the rest of the portfolio, the asset allocation will stray further
and further from the preferred profile.
Are participants using lifestyle funds as a one-stop
solution for retirement investing? Apparently not: A recent Hewitt Associates study found
that, in one company with more than 10,000 401(k) participants, 88 percent were using
these funds in combination with other investment options.
This practice can defeat the purpose of lifestyle funds by
drawing the investor's overall retirement portfolio away from the efficient frontier
sought by the funds. Some say this constitutes a misuse of the funds, presuming that
participants just don't understand what they're doing.
But, others argue that participants are a little savvier
than the experts think. For example, the chief investment officer for the $1.8 billion
State of Alaska 401(a) plan, Anselm Staack, a CPA, has a portion of his own money invested
in the plan's Target 2010 life cycle fund as well as other investment options.
"As a participant, I like to have some professional
asset allocation," he said, "but people are becoming a lot more sophisticated
than the professionals are giving them credit for."
|
"People are becoming a lot more
sophisticated than the professionals are giving them credit for."
|
— Anselm
Staack, chief investment officer for the State of Alaska Retirement System.
|
|
The important part of any investment portfolio is that it's
designed according to your individual needs. Of course, it's also possible — and even
likely — that people who supplement their lifestyle fund choices with additional
funds are taking on more risk than is appropriate for them.
Not Just for Age 65 Anymore
Investors aren't using their retirement accounts solely for
age 65 retirement. "It's not just about retirement age, but it's also about what you
intend to do with the money, and when," said Staack. If you've planned to take some
money out of your retirement account early, then it would make sense to have that money in
another investment with a different risk profile. Just be sure that you aren't selling
yourself short with that early withdrawal. Many people who plan to take out money in a few
years "overcontribute" to build up the balance.
If, for example, you wanted to purchase a house in three
years with a down payment from your 401(k), financial planners would probably recommend
that you put that money into more conservative investments, like bonds and money market
accounts. The remainder of the account could still be invested in your asset allocation
portfolio for retirement, whether in a profile fund or your own mix of funds.
This sort of multigoal investing transcends the typical
characterization of the 401(k) as an account used only for retirement. But, because of the
potential difficulty of accessing your money early with a 401(k) or other retirement
account, and potential penalties, it's a good idea to investigate other types of
investments for shorter-term goals.
It's Easy ... If You Do the Work
While these profile funds can be a great tool for
investors, there are several pitfalls. The only way to avoid falling into these traps is
to research the profile fund. Of course, this defeats the purpose of these funds for many
investors: In the time it takes to research a lifestyle fund, you could be educating
yourself about stock and bond choices you could make on your own. The good news is that,
if you find a manager that you trust, you'll probably sleep a lot better.
Lifestyle fund pitfalls include:
- Poor underlying options. If the profile funds are not
created from your 401(k) plan's specific funds, you could end up investing in some real
dogs. Some companies will offer a preset mix that can consist of poor-performing and
expensive options. If all of the underlying investments are offered by a company whose
mutual funds are concentrated in a few stocks, you could also have problems with
diversification. "Diversification is also about managers," said Staack.
- Fees. Make sure that any additional
"administration charge" is really worth it. Even a seemingly small fee of 0.25
percent could make a significant difference in your balance by retirement age. Also, if
the underlying funds are unfamiliar to you, you may want to check to see if their expense
ratios are out of line with the other investments in your plan.
- Cookie-cutter profiles. Although most plans will
offer up to five different profile funds, there are almost certainly more than five
different types of investors in the plan. Make sure that your own investor profile is in
line with that of the fund and that you are comfortable with the level of risk that you
are taking.
|
