Lifecycle Retirement Funds 101

07/29/2005 12:00 am EST

Focus:

Sheldon Jacobs

Author, Investing Without Wall Street, Five Essentials for Financial Freedom

"There is an increasing number of lifecycle funds whose allocations change as time passes toward your retirement date," notes Sheldon Jacobs. "Investors who value simplicity, above specialized fund selection and asset-allocation shifts, may find much to like in these funds."

"Vanguard, T. Rowe Price, and Fidelity offer a broad number of retirement lifecycle funds. (American Century and Schwab also offer them but we do not track them because they are newer and lack sufficient track records for our analysis.) While these firms' lifecycle funds differ significantly from one another, they share a chief trait: the greater the number of years before the target retirement date, the greater the percentage of assets held in stocks. Historically, that has been a winning strategy. The longer an investor has held a truly diversified portfolio of stocks, the less likely he or she has been to lose money.

"The S&P 500 index of large US stocks produced a cumulative gain (including dividends) in every single one of the 697 rolling 20-year periods from 1926 through 2003. The worst result was an annualized gain of 1.89% for the 20-year period ended August 1949. While intermediate term US government bonds have produced losses in several of the past 75 years, they have produced gains over any period of five years or longer. Equally important, such bonds have produced positive total returns in almost every year the S&P 500 has fallen since the late 1920s.

"Retirement lifecycle funds gradually increase the percentage of fixed income investments in their portfolio as you draw closer to your target retirement year. These funds typically hold intermediate-term bond funds for this allocation, although a wider variety of fixed-income funds and cash equivalents are not uncommon. Instead of investing in individual stocks and bonds, the retirement lifecycle funds from Vanguard and Fidelity invest in as few as four and as many as 23 of the offering fund family's other funds.

"While the returns of some other so-called funds of funds suffer from an extra layer of expenses over those of the underlying funds, the lifecycle retirement funds from Vanguard, T. Rowe Price, and Fidelity levy no extra cost on the investor. They also boast the simplicity of one statement, a professional asset allocation that changes over time without instruction from you, and low investment minimums, especially compared to the amount of money it would take to establish minimum investments in all the underlying funds on their own.

"Vanguard's lifecycle funds are called Target Retirement Funds and include funds of funds for investors who expect to retire on or about 2005, 2015, 2035, and 2045. We note that the Vanguard funds are awfully conservative; for example, the 2025 fund currently devotes under 60% of its assets to stocks, compared to our Wealth Builder portfolios, which hold 85% of assets in stock funds. The T. Rowe Price Retirement Funds stress significant equity exposure. Its offering, with retirement years ranging from 2005 to 2045 in five year increments, are quite aggressive. While the Price retirement lifecycle funds are attractive for all-in-one funds for those who are aggressive or bullish on the stock market, the allocations of the Fidelity Freedom Funds more closely match the allocations of our Wealth Builder portfolios. The Fidelity lifecycle funds run from Freedom 2000, in five-year increments, to the Freedom 2040.

"Small investors who like to spend as little time as possible on their portfolios are best suited for lifecycle funds. That's primarily because the funds enable investors to possess reasonable, diversified portfolios with one small investment. Also, as lifecycle funds use taxable bond funds and are likely to sell off appreciated stock holdings over time, they are likely to make substantial taxable distributions as the years pass. Thus, the funds are more appropriate for IRAs and other retirement accounts. None of these funds is trying to set the world on fire. All are simply trying to steer a prudent course to retirement safety. So you really can't go wrong with any appropriate retirement lifecycle offering from Fidelity, Vanguard, or Price."

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