Life cycle funds (also known as target date funds) are meant for long-term investors who want to use a set it and forget about it approach. These types of funds use a specific date for their investments horizon (like 2045 or 2050) and allow the fund manager to determine an appropriate strategy based on the time remaining until retirement.
The four main components are:
- Early Growth Phase – Investors will primarily invest in growth assets, such as equities.
- Middle Stage – Funds will gradually reduce their equity exposure while increasing their allocation to fixed-income investments.
- Final Phase – Funds will become more conservative by focusing primarily on capital preservation and income generation.
- The gradual reduction in equity exposure over the years is referred to as the Glide Path.
Common Names for Life Cycle Funds:
Some major companies that offer life cycle funds include:
- Vanguard – Low-cost Target Retirement Funds.
- Fidelity Int’l – Freedom Funds, both active and indexing.
- T Rowe Price – Retirement Funds, with active money management.
You can find these funds in many 401(k) plans and/or Individual Retirement Accounts (IRAs).
The main reasons investors choose these funds include:
- Very little ongoing management is required.
- They periodically rebalance automatically over time.
- There is built-in diversification in the fund.
- Risks are aligned to your age.
- Life cycle funds perform the function of default investment options in a variety of retirement plans offered by employers.
The Downsides:
- The primary drawback to life cycle funds is that they are not suitable for all investors.
- The glide path of a life cycle fund may not be appropriate for investors who have a specific risk tolerance that is higher or lower than the glide path provided.
- Fees will vary by provider.
- Retirement plans offered by different providers will not have the same investment strategy.
- The two funds are also likely to have different underlying allocations, even if the stated target year for the fund is the same.
Read more: What is 65-10-10-15 investment method?
Conclusion
Life cycle funds are a simplified way for people to invest and automatically change their risk profile over time. They may be the best option for an investor if you are looking to invest a long-term, passive investment; however, an investor must understand the methodology and costs behind any investment they make prior to purchasing or opening an account with an investment company.
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