Some people love to fiddle with their finances. They routinely update their financial software, reconcile their bank accounts, and monitor the stock market to track the status of their 401(k) investments. Others would rather leave such tasks to experts or a financially savvy relative or friend. For this second group, life cycle funds (also known as target date funds) can be a good option for hassle-free investing. These funds contain holdings that tend to become less risky (at least in theory) as the target date approaches.
Suppose, for example, you hope to retire in 20 years at age 65. You could invest in a mix of index funds containing shares in small and large U.S. companies and international firms, as well as high-grade bonds and U.S. treasury bills. But managing your own portfolio takes time and at least a smidgen of investment know-how. On the other hand, another option is to place your retirement savings in a single account today that's invested 60% in stocks and 40% in bonds. Fund managers would gradually revise the investment mix over the next 20 years so that when you're ready to retire, the portfolio would be invested 80% in bonds and 20% in stocks. That's the essence of a life cycle fund.
Do these funds make sense for you? As usual, it depends on your financial goals, your tolerance for risk, your level of investment knowledge, and the time you're willing to devote to monitoring and rebalancing. If you prefer to "set and forget" your investments until needed, a single life cycle fund may be a great way to save for the future. And if the market plummets as you near retirement, you might escape the temptation to sell at an inopportune time.
It's important to note some life cycle funds tend to charge heftier fees than garden-variety mutual funds because of the higher level of management required. In addition, by including a life cycle fund in a larger overall portfolio, you may find it difficult to coordinate with your other non-target date investments. Some financial experts also believe that life cycle funds tend to be overly conservative, lessening their efficiency as a hedge against inflation.
If fiddling with your finances is a task you'd rather avoid, consider the pros and cons of life cycle funds before you invest.
© MC 2017