A Life-Cycle or Lifestyle Fund? A Critical Investment Decision

The research is plain: Participants in 401(k) plans and retail investors generally seem determined to simplify their investment decision making. They have shown a preference for funds that diversify over a number of investment classes, managing, in a single purchase, to buy a mix of needed assets. There are a great variety of such funds, but they tend to come in two basic types: 1) those structured to the investors’ life cycle and 2) those structured to meet specific investor objectives and risk tolerances. The former, the life-cycle approach, is dominated by age-based funds. These combine assets—stocks, bonds, international investments, etc.—according to a set schedule based on the investor’s age and nearness to retirement. The latter, often called lifestyle or risk-based funds, aim to satisfy specific investment objectives and needs regardless of the investor’s age or nearness of retirement. While the life-cycle approach works for many, it carries certain rigidities that recommend the more flexible and individualized lifestyle approach.

The Issue of Individuality
Individuality is a critical consideration. Just because two people are the same age does not mean that they have the same investment needs or risk tolerances. A 38-year-old who has saved regularly for the prior 15 years has very different investment needs than another 38-year-old who has had some false starts in his career and has done very little saving. The late starter might want to make up for lost time and, accordingly, likely will seek a more aggressive investment portfolio than the first investor, who might well see a greater need to protect his nest egg and so prefer a more conservative approach. Despite such differences, life-cycle funds, guiding off age alone, treat these two investors in exactly the same way.  Each might do better drawing in an array of lifestyle funds, with one opting for a more conservative and the other for a more aggressive asset mix.

The Issue of Flexibility
Yet life-cycle funds can rarely cope with life’s inevitable surprises. A divorce at 50, for example, might severely deplete what seemed like a secure investment nest egg, leaving its owner, despite his or her age, with a need to rebuild his or her asset base and, consequently, a concomitant need to take an aggressive investment posture. On the opposite side of the scale, a large inheritance at 40 might alter a person’s asset base sufficiently to turn all previous strategies on their head. An unexpected child or other dependant could similarly disrupt a person’s financial plans so that the prescribed age-based mix might not apply, might even suddenly seem counterproductive. Very unlike the life-cycle or age-based approach, an array of lifestyle funds would allow the investor to adjust strategy in response to such changes.

Post-Retirement Issues
Other problems with life-cycle funds can arise even after retirement. Unlike past generations, people retiring today plan to live for many years. At 65 years of age, for instance, the U.S. Census Bureau estimates in excess of 20 years of reasonable life expectancy. Over such an extended period, any investment should at least partially protect its owner from the ravages of inflation. Since many life-cycle funds roll assets into an annuity at the time of retirement, they may fail to offer such protections. A lifestyle approach, carefully selected, can, however, provide a measure of needed inflation protection over the years of retirement.

A Coincidence of Interests
In one other important respect, it is bewildering why any financial advisor would recommend a life-cycle or age-based investment. Because the approach effectively locks the investor into a preset schedule, the decision blocks any room for additional advice and so, in effect, puts the advisor out of a job. Beyond the selfish motives of an advisor, it also should be clear that there is good reason, from a client’s viewpoint, to pause before rolling into a life-cycle or age-based approach, with its lack of individuality and flexibility, and consider lifestyle funds in its place.

© Lord Abbett

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