Saturday, May 13, 2006

investing: evaluating lifecycle funds

As I've written before, I'm a big fan of lifecycle funds. Historically I've never had the discipline to rebalance my portfolio on a regular basis - lifecycle funds take care of that for you and update your portfolio as you age.

Virtually all of my retirement holdings are in SWERX - schwab 2040. Being in my late 30s, I straddle between 2030 and 2040 retirement dates, but prefer the more aggressive allocations of the younger 2040 allocation.

Also, I expect to work part time in retirement and therefore have some income to allow me to defer retirement income. If you intend to work in retirement, you may want to reassess which target date is right for you.

One benefit of the funds of funds approach is you have access to funds that might otherwise require much larger minimum initial investments ($1M or $500k).

Morningstar recently released an article discussing how to evaluate life cycle funds. You can see it here.

Keep in mind that the article is mildly self-promoting; i.e. you can use morningstar's premium tools to perform your own analysis. However, several basic points are quite good. Core points are:

  1. Not all lifecycle funds share the same allocation between asset classes, some are heavier in equities than others.
  2. Although most lifecycle funds are expected to be held in tax deferred accounts, such as 401ks, sometimes they are not (I hold a small amount of SWERX in my trading account due to an accidental over contribution). Morningstar recommends Vanguard's index based lifecycle funds for out of retirement accounts. In the future I'll try to share information on the tax events I face holding SWERX outside of my retirement accounts.
  3. Beware what lifecycle accounts do to your overall portfolio (retirement and non-retirement). I recommend examining your overall portfolio with all of your accounts. You could easily have duplicate holdings or too many in once specific sector or asset class once you add lifecycle accounts. My solution to this problem was to eliminate all non-lifecycle holdings in my retirement accounts. I'm using an ETF strategy in my non-retirement accounts and will begin emphasizing overseas investments to increase my overseas allocations for my entire portfolio. Morningstar recommends their free xray utility to compare various holdings across your funds portfolio and discover where you are either overweighted or underweighted.

I hope these thoughts are helpful.

Have a wonderful Saturday,



traineeinvestor said...

Lifecycle funds are a useful concept. The only issue I have with them is that they tend to go overweight in bonds once people approach and commence retirement. For those looking at 30+ years of retirement and worried about inflation (which I believe is generally higher than the CPI figures), I have to wonder whether having a heavy exposure to bonds is sensible for such long periods?

makingourway said...

I agree with you about the latter stage conservatism in life cycle funds, consequently, I invest in a fund slightly young (ie targetted at a younger age group) than my own to keep the equity side up.

In addition, my out of retirement funds are in index ETFs which I imagine will remain that way into or through retirement.

Thanks for sharing the thoughts,
have a wonderful day,