Life-Cycle Fund

Life-Cycle Fund

What is a life cycle fund?

Life cycle funds are asset allocation funds in which the share of each asset class is automatically adjusted to reduce the risk as the desired retirement date approaches. In practice, this generally means that the percentage of bonds and other fixed income investments is increasing. Life cycle funds are also called “age-based funds” or “target date retirement funds”.

A young investor who is saving for retirement generally chooses a life cycle fund with a target date of 30 to 40 years. However, an investor approaching retirement age might consider a professional retirement with income from a small business. Such an investor could choose a life cycle fund with a target date which is 15 years in the future. Accepting higher volatility can help stretch the retirement funds over the 20 years or more of old age that most people can expect.

Lifecycle funds are based on the idea that young investors can manage more risk, but this is not always true.

How a life cycle fund works

Life cycle funds are designed to be used by investors with specific objectives that require capital at specific times. These funds are generally used to invest in retirement. However, investors can use them whenever they need capital at some point in the future. Each life cycle fund defines its time horizon by naming the fund with a target date.

An example will help explain how a life cycle fund works. Suppose you invest in a life cycle fund with a target retirement date of 2050 in 2020. At first, the fund will be aggressive. In 2020, the fund could hold 80% stocks and 20% bonds. Each year there will be more bonds and fewer stocks in the fund. By 2035, you should be halfway through your retirement date. The fund would be 60% equity and 40% bonds in 2035. Finally, the fund would reach 40% stocks and 60% bonds by the target retirement date of 2050.

Life Cycle Benefits of Funds

For investors with a targeted need for capital on a specific date, life cycle funds offer the convenience. Lifecycle fund investors can easily put their investing activities on autopilot with a single fund. The capital allocations of lifecycle funds promise to give investors the right balanced portfolio for them every year. For investors looking to take a very passive approach to retirement, a life cycle fund may be appropriate.

Most life cycle funds also have the advantage of a predefined glide path. A predefined trajectory offers investors greater transparency, which gives them more confidence in the fund. The downward trajectory of a lifecycle fund predicts a constant decrease in risk over time by shifting asset allocations to low risk investments. Investors can also expect a lifecycle fund to be managed until the target retirement date.

Life Cycle Fund Reviews

Some critics of life cycle funds claim that their age-based approach is flawed. In particular, the age of the bull market may be more important than the age of the investor. Legendary investor Benjamin Graham suggested adjusting investments in stocks and bonds based on market valuations rather than your age. Drawing on Graham’s work, economist Robert Shiller, Nobel Prize winner, advocated the use of the P / E 10 ratio as a measure of stock market valuation.

Lifecycle funds are based on the idea that young investors can manage more risk, but this is not always true. Young workers generally save less money and almost always have less experience. As a result, young workers are exceptionally vulnerable to unemployment during recessions. A young investor who takes high risks could be forced to sell stocks at the worst possible time.

Investors may also prefer a more active approach. These investors should seek a financial advisor or use other types of funds to achieve their investment objectives.

KEY POINTS TO REMEMBER

  • Life cycle funds are asset allocation funds in which the share of each asset class is automatically adjusted to reduce the risk as the desired retirement date approaches.
  • Life cycle funds are designed to be used by investors with specific objectives that require capital at specific times.
  • For investors looking to take a very passive approach to retirement, a life cycle fund may be appropriate.
  • Legendary investor Benjamin Graham suggested adjusting investments in stocks and bonds based on market valuations rather than your age.
  • Lifecycle funds are based on the idea that young investors can manage more risk, but this is not always true.

Real life cycle fund example

The Vanguard 2065 Target Retirement Trusts are an example of a lifecycle fund. In July 2020, Vanguard launched its lifecycle offering for 2065, the Vanguard 2065 Target Retirement Trusts. The fund provides an example of how lifecycle funds transform their risk management allocations.

The Vanguard Target Retirement 2065 asset allocation remains fixed for the first 20 years, with around 90% in equities and 10% in bonds. For the next 25 years leading up to the target date, the allocation gradually moves more towards bonds. On the target date, the asset allocation is around 50% in equities, 40% in bonds and 10% in short-term TIPS. The allocation to short-term bonds and TIPS continues to increase gradually over the seven years following the target date. After that, the allocation is set at around 30% stocks, 50% bonds and 20% short-term TIPS.

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