Many people are so busy, they don't have time to follow their portfolios. Most haven't had the necessary training or education to understand the ins and outs of investing. The good news is that there are funds out there that – based on your age and risk tolerance – take all of the guesswork out of where to put your money. These funds go by several names, such as age-based allocation models, age-based funds, or target-date funds, but they all are designed to assist the investor by investing on the basis of their age at planned retirement.

Age-Based Funds vs. Lifestyle Funds

Age-based funds are normally set up as mutual funds. Generally, the funds are set up so that the younger you are, the more risk your fund will take on, since you have time to make up for any significantly adverse market moves. As you age, the fund takes on less risk in preparation for your pending retirement and dependence on the funds that liquidating your investment will yield. (For more on this, read Bear Market Mauls Target-Date Funds.)

Target-risk funds, or lifestyle funds, also rate assets based on risk over time, but instead of being based on age, they are based on whether you consider yourself to be conservative or liberal in your risk tolerance. For this discussion, we will focus on the age-based funds that allocate assets based on a future retirement date.

What are the differences between lifestyle- and age-based funds? Both funds invest your money in stocks, bonds, and cash, but lifestyle funds are based more on a person's risk tolerance, which could stay basically the same throughout his or her lifetime. Age-based funds automatically change as the person ages. With a lifestyle fund, there are no changes unless the person investing in them decides to move to a more or less aggressive fund. This does require action on the part of the investor. With an age-based fund, once the fund is chosen, no action is necessary.

Traditionally, age-based funds have been thought of as retirement funds. At the same time, they are increasingly being used for 529 plans. A 529 plan is a mutual fund set up for college savings. As with retirement funds, the 529 fund changes its risk as the beneficiary of the money ages. One issue an investor should be aware of is that there may be some duplication of investing in similar funds outside of a 529 non-taxable plan. Should this be the case, it may become necessary to individualize portfolios in both 401(k) and 529 plans. (Learn more about 529 plans in our tutorial on 529 Plans.)

Misconceptions About Age-Based Models

There are misconceptions about age-based allocation models. For example, they may not be perfect for anticipating life expectancy past the time of retirement. Should someone retire early or live longer than average, these funds do not account for that. These funds also offer no guarantees that your money will have maximized returns. They are not like a Social Security fund, from which one can expect a certain payout.

It is also important to remember that all target-date funds are not alike. They can diverge significantly, based on which fund family is chosen for the investment. A fund may offer the same year of retirement, but one manager's idea of a good investment may not be exactly the same as another's. Remember, these are akin to regular mutual funds, in that they carry inherent risks. Just because something is risk-adjusted based on age, doesn't mean that no risk is there.

Their Allocation Mix

As we age, normal funds would require that we move our money around in order to reduce our risk. The nice thing about age-based funds is that, as we age, they are rebalanced for us. This makes investing in these funds much simpler for those who don't have the time or market knowledge to make adjustments. Instead, the fund manager deals with adjusting the balance between risk and return. As parts of the portfolio grow and become dominant, the manager can make necessary changes, moving securities around to bring the fund back into balance.

As with regular mutual funds, these funds have ratings, in order to give investors an idea of their safety and return. The fund's Morningstar Risk score assigns ratings stars to these accounts. A fund with the lowest rating would receive one star, while a fund with the highest rating would receive five stars. These ratings are recalculated monthly, and should be something an investor monitors to be sure that their fund's ratings are not changing dramatically. (See our article Morningstar Lights the Way for more information on Morningstar.)

While evaluating funds, remember that because these funds are somewhat new, data on past performance may not be available to the same degree as it is for funds that have been on the market for many years. There will still be expense ratios to consider, which will be listed in the fund's prospectus. Compare funds to see what fees they are charging. The nice thing about these funds, just as with any tax-deferred investing account, is that rebalancing will not have tax consequences until the money is actually removed from the account, ideally in retirement.

The Advantages of Investing in These Funds

Probably the biggest advantage of investing in age-based accounts is the convenience that comes with not having to worry about moving money around. If you are a 'set it and forget it' kind of person, they may be the perfect investment vehicle for you. Indeed, when it comes to financial choices, many people prefer to know that an expert is making the decisions for them.

These funds are also a great choice for the beginner investor. A young person just entering the working world may find that a fund like this is the ideal way to start investing. They can always go back later and move things around once they learn the investing ropes. It would be intimidating for a young investor to pick risky stocks, but having the knowledge that there is a pre-set fund that backs some of these types of choices could alleviate some of their fears.

Age-based funds are also highly diversified. They can include stocks, bonds, cash, or other types of investments that many people may not fully understand, but whose possible advantages are manifest. These may include international funds or other such funds that would not be the typical first choice for the uninformed investor. (To learn more, read The Pros And Cons Of Target-Date Funds.)

The Disadvantages of Investing in Them

Nothing is ever perfect, and even age-based funds have issues. If you like to have control over your money, these funds may not be a good choice for you. The idea of investing in these funds is to not have to control how your money is handled. Depending on your preference, this lack of control can be considered either an advantage or a disadvantage.

Another possible disadvantage could be the lack of age-based choices you are offered through your retirement plan. As with many employer-based 401(k) plans, employees get a limited number of options to chose from. Hopefully, your company has done its research, and has optimized the choices available to you. (Want to learn more about employer plans? Take a look at our article, 410(k) And Qualified Plans.)

Many people who invest in these funds may not truly understand the fact that they carry inherent risk, just as any other 401(k) option does. As these funds are not all the same, some may involve more risk than others. It's important to keep in mind that retirement may be a long way off, but even if you retire at 65, you could live another 30 or more years and find that your investment hasn't yielded enough money to account for such a long life.

The Bottom Line

The bottom line here is to realize that these age-based funds offer some great advantages to those who prefer a hands-off approach. Still these funds are not for everyone. Even if you decide to invest in an age-based fund, it is wise to do as much research as possible, and to compare your available options. Compare the fee structures, and check out what they say on Morningstar or similar research sites about the funds suggested for you.

If you're near retirement or planning to retire soon, be sure to check out other articles like 5 Retirement Questions Everyone Must Answer.