What Is a Life-Cycle Fund?
I'm here to explain life-cycle funds directly to you. These are asset-allocation funds where the mix of asset classes gets automatically adjusted to cut down on risk as your target retirement date gets closer. In practice, this often means ramping up the percentage in bonds and other fixed-income investments. You might also hear them called age-based funds or target-date retirement funds.
If you're a young investor saving for retirement, you'd typically pick a life-cycle fund with a target date 30 to 40 years out. But if you're nearing retirement and planning a working retirement with some business income, you could go for one with a target 15 years away. Taking on higher volatility can help make your funds last through the 20 or more years of retirement most people face.
Important Note
Keep this in mind: life-cycle funds operate on the premise that young investors can tolerate more risk, but that's not always the case.
How a Life-Cycle Fund Works
Life-cycle funds are built for investors like you who have specific goals needing capital at certain times, most commonly for retirement, though you can use them for any future capital need. Each fund sets its time horizon by including the target date in its name.
Let me give you an example to make this clear. Suppose you invest in a life-cycle fund targeting retirement in 2050, starting in 2020. Early on, it's aggressive—maybe 80% in stocks and 20% in bonds. Each year, it shifts to more bonds and fewer stocks. By 2035, halfway there, it might be 60% stocks and 40% bonds. By 2050, it reaches 40% stocks and 60% bonds.
Benefits of Life-Cycle Funds
For you as an investor with a targeted need for capital on a specific date, life-cycle funds provide real convenience. You can set your investing on autopilot with just one fund. Their fixed asset allocations ensure you get a balanced portfolio suited to your stage each year. If you're after a very passive retirement strategy, a life-cycle fund fits the bill.
Most of these funds come with a preset glide path, giving you transparency and confidence. This path steadily reduces risk by moving allocations to low-risk investments over time. You can count on the fund being managed right through and beyond the target date.
Criticisms of Life-Cycle Funds
Critics point out that the age-based approach of life-cycle funds has flaws. The state of the market—whether it's a bull market—might matter more than your age. Benjamin Graham, the legendary investor, advised adjusting stock and bond investments based on market valuations, not age. Robert Shiller, a Nobel Prize winner, built on that by using the P/E 10 ratio for stock market valuation.
Remember, these funds assume young investors can handle more risk, but that's not universally true. Younger workers often have less saved and less experience, making them vulnerable to recessions and unemployment. If you're young and taking high risk, you might end up selling stocks at the worst time. If you prefer a more active approach, look for a financial advisor or other fund types to meet your goals.
Key Takeaways
- Life-cycle funds are asset-allocation funds that automatically adjust to lower risk as your retirement date nears.
- They're designed for investors with goals needing capital at specific times.
- For a very passive retirement approach, a life-cycle fund may be right for you.
- Benjamin Graham suggested basing investments on market valuations, not age.
- The idea that young investors can handle more risk isn't always accurate.
Real World Example of a Life-Cycle Fund
Take the Vanguard Target Retirement 2065 Trusts as a solid example. Vanguard launched this in July 2017, showing how life-cycle funds manage risk through allocation shifts.
For the first 20 years, the asset allocation stays fixed at about 90% equities and 10% bonds. Over the next 25 years to the target date, it gradually increases bonds. At the target, it's roughly 50% equities, 40% bonds, and 10% short-term TIPS. In the seven years after, bonds and short-term TIPS keep growing. Finally, it settles at about 30% stocks, 50% bonds, and 20% short-term TIPS.
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