Flaws of Target Retirement and Lifecycle Mutual Funds

August 13th, 2007  |  Published in Mutual Funds

I’m a huge fan of target retirement and lifecycle funds, those mutual funds that rebalance based on your age, but a recent article put out by MarketWatch identifies a few critical flaws with these types of mutual funds – flaws that I agree exist but nonetheless do not affect my admiration for these types of funds.

The primary flaw they identify, with which I agree with, is the fact that the target retirement and lifecycle funds are only concerned with one of many factors in your investment profile – your risk profile as a proxy for your age. That is, based on what your age is, they determine a risk profile and invest based on that. So a Target Retirement 2050 is riskier than a Target Retirement 2020 (that is, investors intend to retire in either 2050 or 2020 when they select those funds), but there are a lot of other characteristics involved that they don’t consider.

The second flaw is that there could be the fund overlapping with either other funds or other investments, thus throwing your diversification slightly or quite a bit out of whack. They claim this could be more work, which may or may not be true depending on your diligence, but it certain would be imprudent. At the very least, it would throw your intentions out of line with your actuals, which is bad anyway.

Their third point of every investor being different isn’t something new and it’s not something I consider that big of a deal.

The fourth point of how target retirement funds are not created equal is certainly true. In analyzing the rule of thumb that you should have 120 minus your age as a percentage of stocks in your portfolio, I compared the asset allocations of many popular target retirement and lifecycle funds to see how they differed and how closely they followed the “120 minus age” rule. As you can see, no two allocations for the same date were the same and that’s just looking at it from a stock vs. bond perspective, it’s likely messier even inside those two buckets.

The last point that “set it and forget it” is not a solid strategy anyway is very very true. You should always, at least semi-annually or even monthly, be taking a peek at your investments to see if you’re on track with your plans. You never want to just put it there and ignore it for years… that would be a mistake.

Source: MarketWatch

  

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