Putting all your eggs in one basket
There are really only three things investors can do to safeguard their nest eggs. They can save more before retiring, spend less in retirement, or invest more effectively along the way. While saving more and spending less seem like daunting tasks, the third option has gotten a whole lot easier.
That's because in recent years, dozens of money management firms have come out with mutual funds that expose investors to what is generally considered an age-appropriate mix of stocks, bonds, and cash--all in a single off-the-shelf portfolio.
As you get closer to retirement, these funds gradually--and automatically--become more conservative. The Vanguard Target Retirement 2045 Fund, which assumes you are in your 20s and will retire more than 40 years from today, puts 90 percent of its assets in stocks and 10 percent in bonds. But the Target Retirement 2015 Fund, designed for those who will retire in about a decade, has half its money in equities, with the remainder in fixed-income securities. "For beginning investors who don't know that much about investing or don't have the time or the interest in researching funds, this is an easy, one-step answer to their needs," says Kerry O'Boyle, a fund analyst with Morningstar.
Many of the biggest fund companies now offer life-cycle portfolios. In addition to Vanguard, Fidelity offers its Freedom Funds, while T. Rowe Price goes with its Retirement Funds. And American Century recently launched a version called My Retirement Portfolio funds.
These prepackaged funds are not to be confused with older types of all-in-one asset allocation funds. Those funds, which are sometimes called static asset allocation funds, require investors to select a level of risk they are comfortable with--ranging from conservative to aggressive. But once selected, static funds, available in many 401(k) plans, don't adjust with age.
The biggest selling point of life-cycle funds is that the portfolio manager does all the heavy lifting, including periodically rebalancing the fund so that the mix of stocks and bonds never veers too far off course because of short-term market fluctuations.
Studies show that retirement investors rarely rebalance their accounts, which could lead them to be overweighted in stocks or bonds at the wrong times.
Diversity. Not all life-cycle funds are alike. Vanguard's portfolios invest in a collection of index funds, which track the overall market. Most other life-cycle funds invest in a collection of actively managed mutual funds. There are differences of style, too. A fully retired T. Rowe Price investor will eventually be shifted to a portfolio with only 20 percent in stocks. But the most conservative that American Century's My Retirement Portfolio fund gets is 35 percent in stocks.
And the funds leave little room for personal differences. Two 50-year-old males, for example, might require entirely different asset allocations, depending on their health, tolerance for risk, outside sources of income, and the wealth of their spouse. "These funds are too generic to do much for the individual in terms of his particular situation and particular needs," says Torrance, Calif., financial planner Phillip Cook. Still, for investors who don't have an asset allocation strategy, these funds can be better than nothing.
If you are considering a life-cycle fund, pay close attention to fees. Because these funds invest in other funds, many life-cycle portfolios charge two layers of fees--first, the annual expenses of the underlying funds, and then a top layer of fees for handling the asset allocation decisions. Vanguard, Fidelity, and T. Rowe Price have only one layer of fees. The average total expense for a Fidelity Freedom fund runs below 1 percent, and Vanguard's Target Retirement funds are considerably cheaper than that. -Paul J. Lim
This story appears in the October 25, 2004 print edition of U.S. News & World Report.
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