By definition, a life cycle fund is a fund (commonly a mutual fund) that is automatically adjusted during the life of the fund to match an investor's risk tolerance as he or she nears retirement. The main selling point of a lifecycle fund is convenience -- as you age, the fund will reduce its stakes in riskier assets like stocks to buy safer investments like bonds. Lifecycle funds were made popular by an account known as the Thrift Savings Plan (TSP) for employees of the Federal government, and have since trickled down into private retirement plans.
How lifecycle funds work
The funds offered in Thrift Savings Plans are very similar to funds sponsored by private asset managers, thus we can use a TSP lifecycle fund as an example of how they work.
Thrift Savings Plans currently offer lifecycle funds in four distinct "flavors," with retirement dates in 10-year intervals ranging from the year 2020 to 2050. For example, the L 2020 fund is designed for investors who plan to start withdrawing their money around 2020. Similarly, the L 2030 fund is designed for those who plan to start withdrawing around 2030. The idea is simple: You pick a fund that matches your expected retirement date and the fund takes care of the rest.
As the calendar pages turn and your retirement date nears, the lifecycle fund will automatically change its investment composition to adjust for your changing risk tolerance, following traditional retirement advice that investors should take less risk as they near an age at which they'll begin making withdrawals.
Thrift Savings Plans are very transparent about their funds' "glide paths," or how the funds' allocations will change over time. We charted the allocations for the L 2030 fund based on its guide path below.
A lot can change in just 9 years! During the 9-year period from 2016 to 2025, the fund's allocation to stocks will be reduced by about 20% in every category. The bulk of the proceeds from the sale of stock will be reinvested into super-safe government bonds, thus reducing the investor's risk as he or she nears retirement.
All TSP lifecycle funds eventually shift to a 20/80 stock-and-bond allocation after the selected retirement date passes. Most lifecycle funds follow a similar glide path, though investors who invest in funds administered by other companies should carefully read the funds' prospectus to learn how the fund will be allocated in their post-retirement years.
The Thrift Savings Plan does not have a monopoly on lifecycle funds, however. Virtually any asset manager of any notable size offers some kind of target-date retirement fund. BlackRock has a full line of lifecycle funds it calls "LifePath" funds that it offers in increments of 5 years, from 2020 to 2060. Many other asset managers including T. Rowe Price, Vanguard, and Fidelity offer so-called "target-date funds," which are built on the same concept, just packaged with a different name.
Should you buy a lifecycle fund?
The key advantage to a lifecycle fund is the convenience of having a set-and-forget retirement plan, but investors should be aware of their shortcomings.
Lifecycle funds sold by ordinary asset managers frequently carry an additional layer of fees that traditional mutual funds don't have. It's standard practice for a lifecycle fund to take the form of a so-called "fund of funds," in which the lifecycle fund allocates its investors' capital by investing it in other mutual funds. Thus, investors will pay an annual management fee on the lifecycle fund, in addition to expenses on the mutual funds that make up its portfolio. A double layer of fees can be particularly taxing to a fund's long-run performance, weighing down on its results.
Secondly, though they may do an adequate job of rebalancing your investments as you age, keep in mind that no two lifecycle funds ever follow the exact same path. With less than four years to retirement, BlackRock's 2020 retirement date fund put 49% of its clients' assets in stocks. By contrast, T. Rowe Price's 2020 fund held a whopping 61% of its portfolio in stocks. This is no small matter; in a bull or bear market, results for the company's investors will vary tremendously. It's important that investors do not take convenience for granted -- lifecycle funds require just as much due diligence as traditional mutual funds.
Finally, realize that lifecycle funds assume that your only investment and your only source of retirement income is that one fund. The fund managers can't possibly know what you receive in Social Security or from a pension, whether or not you've paid off the mortgage on your house, or if you have $10 million in cash sitting in your bank account. As such, lifecycle funds are best described as being a "one-size-fits-all" solution, and should not be viewed as an alternative to a customized retirement plan. At best, lifecycle funds aim to be just good enough for the average person.
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