Life Cycle Funds - Basics of Lifecycle Mutual Funds
In the 1990s the first life cycle mutual fund was introduced. It is also known as age-based fund or target-date fund. It was not until recently that lifecycle mutual funds gained great popularity. Since they are targeted towards individuals investing for their retirement years, they are typically found in 401k plans. Even though lifecycle funds greatly facilitate retirement investing, they bring with them many disadvantages you should consider before investing your money in them.
Retirement investing facilitation through life cycle mutual funds
Making the right choice on your investment for retirement is not an easy job since many factors as asset allocation asset adjustment toward the changes occurring over time and rebalance should be considered. Life cycle mutual funds were invented in response to the difficulties that most individuals encountered when having to set their retirement portfolios.
To illustrate the case, consider you have an investment portfolio consisting of 70% of stock mutual funds and the other 30% of bond mutual funds. In case the stock mutual funds do better than the bond mutual funds, you will need to rebalance your portfolio since you may end up with the undesired asset allocation of 75% in stock mutual funds and 25% in bond mutual funds or vice versa.
Additionally, when you approach your retirement years, you may decide that your needs will be different and choose to allocate 30% of your portfolio to stock mutual funds and 70% to bond mutual funds.
This is just a simple illustration that eliminates many other implications, which interfere in the set of a retirement portfolio.
In order to facilitate your work on choosing on the exact asset allocation and greatly reduce your burden, you should consider the investment in a lifecycle fund since it does this job for you. There are mainly two types of lifecycle mutual funds:
- Target-Date Lifecycle Mutual Fund
The target-date lifecycle mutual fund is connected with a particular date in the future, which you have determined as your potential date for retirement. As you get near and near your retirement date, the lifecycle fund of this type automatically adjusts the asset allocation for you.
- Target-Risk Lifecycle Mutual Fund
Target-risk lifecycle mutual funds take into consideration risk levels regarding investment. They can be divided in:
Generally, most investors choose to start with the aggressive type when they are still in their early career path. Then they transfer to the moderate type and when they approach their retirement years they decide on the conservative type which is generally known for its low level of risk. However, it is up to the individual investor to decide on the exact composition of his/her investment portfolio and when exactly is the right time to switch from one risk type to another.
Disadvantages of Lifecycle Mutual Funds
Since every person has his/her individual needs, the common approach will not apply to all investors. Since the needs of a single mother with two kids to take care of will be greatly different from the needs of a single man making good money out of his managerial position at a leading company, the portfolio needs of both of them will sufficiently defer. What is more, every company offers its potential clients different portfolio allocations as regards the target-date funds.
Some of the drawbacks that we consider worth mentioning and knowing about are:
- underinvestment in international funds
- underinvestment in value stocks
- underinvestment in small companies
- hold too much in cash
- active mutual fund investment - tend to ignore investments in index funds
- narrow fund selection to choose from - this is caused by the fact that most lifecycle funds invest in mutual funds that are within the fund family
- too far in time fund availability - unfortunately, it may be as far as 6 years until you can purchase the appropriate lifecycle for you.
Another drawback of lifecycle mutual funds is that there is a trend of selling through the path of least resistance. Unfortunately, this means most of the time that trade is done within the US borders and includes mainly large-growth stocks. As a result you may end-up short-changing yourself.
Depending on the time you can afford to spend adjusting your investment portfolio, you can choose or avoid lifecycle funds. The investment in lifecycle mutual funds is recommended whenever you don't have the sufficient time to study the changes in your portfolio and make the necessary adjustments yourself. On the other hand, you should not invest in life cycle mutual funds whenever you can afford to observe and adjust your investment portfolio for yourself.
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