Should I use Lifecycle funds or pick my own investments inside my company's retirement plan?
I am 27, with a wife and two kids, and I recently got a job where my employer will match a contribution to a TIAA-CREF Retirement plan. I can either use their Lifecycle funds, or pick my own allocations between equities, real estate, fixed income, money market accounts, and annuities. What makes the most sense for someone like me?
Glidepath funds (AKA Lifecycle funds) are great for the investor who wants to put their retirement investing on autopilot. Lifecycle funds are meant to adjust the asset allocation from more aggressive to more conservative as you approach retirement. What this means is that you get professionally managed pre-set allocation portfolios that gradually shift from a growth strategy to a principal preservation strategy.
Unfortunately, there is a bone I have to pick with lifecycle funds. My issue is that you are unintentionally setting your portfolio up to time the market. What if the timing of your gradual decline in stock exposure happens at an inopportune time? You are SOL, that is what! And the fund didn't do what it was meant to do. Furthermore, not all lifecycle funds use the same steepness in slope in terms of their shift away from stocks to more conservative asset classes like bonds and cash.
On the other hand, lifecycle funds are usually a better alternative to letting an amateur investor select their own funds. The reason is that most novice investors chase yesterday's winners, buy high and sell low, and don't properly diversify their accounts.
Customizing a portfolio and selecting the right lineup of funds is usually best saved for the investor who knows what they are doing or the investor that has a financial advisor assisting them. An advisor can be especially helpful by matching assisting the retirement plan participant in matching the fund mix to their risk tolerance and overall goals.
However, if you choose to DIY, the best way to figure out the right mix of investments is to take a risk tolerance questionnaire - Vanguard has a free tool or you can click the previous hyperlink to mine and see how you score out. Once you have your risk score, use the results to map over the right amount of exposure to each investment asset class (i.e. large cap, small cap, international). In addition, I recommend you set up your investment allocation to automatically rebalance at least annually. This ensures you stay within the risk range you are most comfortable with, as well as accomplishes the old adage of "buying low, selling high."
The bottom line is this, like most things in life, choosing a lifecycle fund versus a custom allocation within your retirement plan is very much tied to each person's individual circumstances. What's right for one person isn't going to be right for another person. Really the best thing you can do as an investor is to stay diversified and keep a long-term perspective. For those who remain disciplined and stay patient, the intended results usually follow.
Thank you for your question!
You should first consider what your Asset Allocation strategy is, then you should consider whether you want to be actively involved with your account or to put it on auto pilot more or less. Also, make sure to consider the internal fees/expenses of each option.
Meeting with a qualified professional to help determine the right strategy would be a good place to start.
Please consider me a resource should you have any further questions.
That's a great question and really depends on you. Also, congratulations on getting an early start. I personally am not a fan of lifestyle funds and believe with some research, you may be able to do as well or better including costs and risks. And at the very least, will get an education even if you don't do quite as well. But if you are not going to pay attention and don't care too much about investing, then the lifestyle funds may be appropriate for you.
For example, if you are picking the 2050 fund, meaning the longer term, more "aggressive" fund, it will have a lot of overseas exposure in emerging markets. If the dollar does continue to get stronger due to new government policies, emerging markets will come under pressure and I don't think the risk merits the return right now. That could and will change, but for now I am avoiding. But even if you wanted the lifestyle allocation, you can simply look at the fund itself and mimic their allocation with the best funds offered. I would also avoid any longer term bond funds due to the probability of rising rates, and when rates rise, bonds go down in value. And the longer the bond, the more it goes down in value as rates rise. But as young as you are, any allocation appropriate for your age will not have a large bonds exposure anyway.
Right now, I think the best opportunities are in our own U.S. equity markets. But I do this for a living and will make occasional adjustments when necessary based upon opportunities and risk. If you decide to invest on our own, you need to re-evaluate every quarter or at least every 6 months in my opinion. No one cares more about your money than you, and I feel everyone should take an active role in their own retirement even when/if hiring a manager.
One thing you should NOT do is do annuities inside your retirement plan. They have a high fee structure and you can invest directly in any fund or one very similar without having to go into the annuity wrapper first. I see teachers all of the time put their 403(b) assets into an annuity then into an S&P 500 mutual fund when they could have invested directly in the exact same S&P 500 fund without having to go into the annuity first and pay the extra fees. And your retirement plan is already bulletproof from creditors so the asset protection the annuity offers is completely unnecessary in any type of retirement plan.
You are asking the right questions and I hope I stimulated your thought processes even more. Best of Luck, Dan Stewart CFA®
Life cycle funds can be a useful tool for new investors. It gets problematic once the employee starts to accumulate assets outside the retirement plan. The asset allocations in the target date plans assume that your entire portfolio is contained within the retirement plan. That is not the case for real world investors. However, at age 27 with a couple of children, I assume that most of your investments thus far will be in the TIAA-CREF plan.
The TIAA-CREF target date 2050 fund, for example, uses a decent set of investment products. I might quibble with the 0.70% management fee and growth bias to their equity allocation. But overall, it's a good way for an investor like yourself to start out. Once you accumulate after tax money and perhaps make some separate IRA contributions, you should seek out an investment advisor that can counsel you on optimal asset location. For example, you might want to concentrate bond assets in your retirement plan since they benefit more than stocks from the plan's tax shelter characteristics.
Bottom line, TIAA-CREF's target date plans have four star (out of 5) ratings from Morningstar, a reasonable fee structure, and diversified holdings. At a minimum, they are a good place to be while most of your assets reside in your employer's retirement plan. Once you move beyond this initial phase, you should consult a professional on how to best locate your stocks and bonds among your various accounts.
My opinion is to pick your own, or go to a financial planner to seek advice. My main issue with target date funds is that the investment allocations are changed based on attainment of certain ages or time frames rather than what is happening in the market. Imagine turning a certain age in 2009 where the fund automatically sold holdings in stocks, which were severely distressed and bought bonds which were extremely expensive. You could have made better choices if you had your own allocation. I am sure you will hear varying viewpoints, but that is my opinion.