Even though the investment industry might have you think otherwise, investing for your retirement does not have to be difficult. Still, many people turn to investment advisors for help. Unfortunately, because of how advisors are compensated, there may be conflict between what is best for them and what is best for their clients. Life-cycle funds offer a viable solution. Here we'll examine what these funds are, compare different ones, and finally look at some issues to consider before using these funds for your retirement portfolio.
What Are Life-Cycle Funds?
Life-cycle funds are one option for maintenance-free retirement investing. Life-cycle funds, also referred to as "age-based funds" or "target-date funds," are a special breed of the balanced fund. They are a type of fund of funds, structured with equity and fixed income. The distinguishing feature of the life-cycle fund is that its overall asset allocation automatically adjusts to become more conservative as the targeted retirement date approaches.
Life-cycle funds are offered from a plethora of institutional managers. They may also be offered in any type of qualified, employer-sponsored plan. As such, they can also be smart investment choices when making investing decisions for your 401(k), SEP IRA, or SIMPLE IRA. Keep in mind that any investments in most IRA accounts as well as all qualified, employer-sponsored plans are subject to required minimum distributions which must begin at age 72.
- Life-cycle funds are designed as a solution for retirement planning and investing.
- Life-cycle funds offer maintenance-free retirement investing with allocations that are automatically rebalanced to become more conservative as the designated target retirement date approaches.
- Vanguard and Fidelity are the top providers of life-cycle funds, with investment fund offerings that can be very different.
Vanguard is the largest life-cycle fund provider in the United States. To get a better understanding of how these funds work, let us look at the Vanguard Target Retirement 2040 Fund. This fund targets people who aim to retire a few years before or after 2040.
As of December 31, 2019, the asset mix and holdings for this fund were as follows:
In comparison, the Vanguard Target Retirement 2030 Fund has a more conservative asset mix with an intended retirement date of around 2030.
Differences: Vanguard vs. Fidelity
While all life-cycle funds are similar in concept, they can be structured and maintained differently. When shopping for a life-cycle fund there are some important factors on which to compare different funds. To help in analysis for which is best for you, we compare Vanguard and Fidelity—the two largest suppliers of these funds. While serving as the largest suppliers, both have some very different offerings.
36.5% and 19.4%
The respective life-cycle fund market shares for Vanguard and Fidelity through 2018.
What this means is Vanguard’s target date funds are comprised solely of index fund allocations. Fidelity however, offers investors both passive and active options. The difference is in the name, which can be important for investors to notice when shopping at Fidelity.
Fidelity’s pure target date options for the investor class for 2040 include:
Choosing between active vs. passive funds can present a substantial difference, primarily when it comes to fees but also when it comes to returns. The main point here is the fees.
Below is a breakdown:
- Vanguard Target Retirement 2040 Fund (VFORX): gross expense ratio of 0.14%, minimum investment of $1,000
- Fidelity Freedom® Index 2040 Fund (FBIFX): gross expense ratio is 0.12%, no minimum investment
- Fidelity Freedom® 2040 Fund (FFFFX): gross expense ratio is 0.75%, no minimum investment
As you can see, the index fund expenses are much lower. Thus, when you decide to invest in a more expensive fund, do be sure to determine whether the higher costs are worth it. That is, ask yourself if the fund with a higher cost is likely to render returns beyond what you would save by going with a cheaper fund.
Also note there are minimum investments, which may influence your entry into a fund. Minimum investments can also vary if a fund is invested in through an employer-sponsored plan vs. a standard brokerage account.
Moreover, Vanguard and Fidelity also differ in the underlying funds they use. As noted above, the Vanguard 2040 Fund invests in:
The Fidelity 2040 Index Fund is comprised of the following:
- Fidelity Series Total Market Index Fund 55.10%
- Fidelity Series Global ex U.S. Index Fund 35.27%
- Fidelity Series Bond Index Fund 6.80%
- Fidelity Series Long-Term Treasury Bond Index Fund 2.82%
Each of the underlying funds has its own benchmark indexing strategy. Differences also arise in the way the funds are benchmarked:
- Vanguard 2040 Fund: Dow Jones U.S. Total Stock Market Index
- Fidelity 2040 Index Fund: S&P 500
- Fidelity 2040 Fund: S&P 500
Another factor to note that can be important for analysis is a life-cycle fund's attention to inflation. The Fidelity 2040 Fund has an allocation to the Fidelity Series Inflation-Protected Bond Index Fund which provides some direct consideration for inflation.
While life-cycle funds are a convenient option for many retail investors (i.e., one-stop shopping along with long-term, no-hassle portfolio management), they are not a solution for everyone—the same asset allocation is not necessarily applicable to everyone at a certain age. As the comparison above shows, mutual fund companies have different takes on what the asset allocation should be for someone retiring in 2040. Getting counseling from a fee-based financial planner (who may be more objective because of his or her impartial compensation) might be a better solution for some investors who want to ensure that their portfolio's asset mix is appropriate for them.
Also, life-cycle funds may only make sense if the vast majority of your retirement funds are in only one of these funds. Adding anything else could alter your overall asset allocation and contravene the whole premise of investing in these funds.
Finally, as life-cycle funds continue to grow so to do other retirement planning options like robo-advisors and asset allocation funds. Automated robo-advisor investing is becoming more popular as a retirement option. Robo-advisors can ultimately help investors to do the same thing as a life-cycle fund but on a larger scale by choosing an array of index funds for a long-term portfolio. Asset allocation funds, including balanced funds, take a more hands on approach but essentially let an investor do the asset allocation balancing and rebalancing for themselves.
For more on target date fund representation in the investment management industry, see also: Morningstar’s 2019 Target-Date Fund Landscape.
The Bottom Line
Life-cycle funds have gained popularity for their convenience and simplicity—something that can be tough to find from investment advisors. Many retail investors are overwhelmed by the responsibility of managing their retirement portfolio and by the bewildering number of investing options facing them. Life-cycle funds make it easy for investors seeking a solution that delivers simplicity, focus, and peace of mind.