One of the hottest new trends in asset allocation for retirement planning involves so-called "life cycle" funds. Basically, a life cycle fund is a mutual fund through which an investor plans for retirement by choosing a target retirement date and the asset allocation automatically changes annually based on that date.
For example, an investor might choose Target Retirement 2015 with a 2006 asset allocation of 65% stocks and 35% bonds. As the target date approaches, the asset allocation mix automatically changes to become more conservative by increasing the fixed-income percentage and reducing the equities exposure. By the time, 2015 arrives, the blend will be about 50% equities and 50% bonds. At the target date, some fund companies may put your money in a conservative income-oriented fund; others may continue rebalancing the investments by substituting bonds for stock for several years after the target date.
The basic advantage of investing in one of these funds is that it can be one-stop shopping. The investor merely selects the target date and lets the fund manager automatically rebalance the fund every year as the target date approaches.
Some of these funds are also very inexpensive, with costs ranging from .21% of assets to 1.25%. A good rule of thumb is that investors should not pay more than a 1% expense ratio.
Another consideration: just how good are these funds? The investor must read the prospectus to determine if the investments the fund selects are in line with his strategic goals. Some target-date funds select investments that do not rise and fall together. This provides good diversification within the portfolio.
Another strategy is to select more than one target date. For example, if you are considering the purchase of a second home ten years before your anticipated retirement date, you might select two funds. One fund would target the home-purchase date, and the second fund would target the retirement date. This insures that funds will be available at both dates to accomplish your goals.
The biggest disadvantage of investing in these funds is that you can't really invest and forget about it. Many advisers think that you should check the performance of these funds at least annually. If the fund is not doing well, consider an exit strategy as you would with any mutual fund. This may not be an option if you are in a 401(k) plan, where the employer chooses the funds and switching funds in a taxable account may be cost prohibitive.
All things considered, these new "life cycle" funds may add an element of comfort to your choice of funds in an already crowded financial supermarket.
The professionals at Marc J. Lane & Company (Member NASD-SIPC), our investment brokerage affiliate, stand ready to assist you with your investment planning.
Mr. Lindgren is an associate attorney with The Law Offices of Marc J. Lane, P.C. He is a CPA and Certified Financial Planner who holds degrees from the University of Illinois (B.A. 1974), IIT/Chicago-Kent College of Law (J.D. with Honors, 1977) , DePaul University College of Law (LL.M. Tax, 1983) and Northern Illinois University (MAS Tax, 1998).
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.