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A Primer on Easy-to-Use 401(k) Funds

Lauren Tara LaCapra

There is a small share of workers who are offered a 401(k) plan, but don't bother to fill out the paperwork or enroll. Companies select a default option for those workers, and a relatively new Labor Department regulation requires that those funds fall into one of three categories: a life -cycle fund, a balanced fund or a managed account.

Life -cycle funds start out primarily weighted in equities, but shift allocation to less-risky holdings as participants approach retirement. Such plans make sense for hands-off investors whose companies offer a 401(k) or who want to plan for retirement, but don't want to be bothered with specific investment decisions.

Balanced funds are just what the name implies -- they are diversified among a range of investments to mitigate risk, but don't change the portion of assets allocated in stocks, bonds or money-market accounts. Managed accounts are for active investors who want a hand in deciding how their investment is distributed. They come with higher fees to interact with account representatives.

The advantage of life-cycle funds is that they do the work for the client. A participant just entering the workforce might have 85% equities, 14% bonds and 1% in cash, but those positions become nearly reversed for someone who has retirement in sight, says Michael Doshier, vice president of marketing for retirement services at Fidelity.

"The attractiveness of a life-cycle fund is someone can buy it when they're 25 and they have a very different risk profile than somebody who's 65, but the fund follows them," says Doshier.

Participants choose lifecycle funds based on the date it will expire, which should correspond with a planned retirement date. (For instance, a 40-year-old investor today would choose a fund that expires around 2035.) Those who plan to gradually move into retirement can also opt to "ladder" funds with different expiration years.

The number of Fidelity Investments plans that maintained a lifecycle fund as the default option has risen from 8% at the end of 2005 to nearly 50% at the end of the first quarter. Those funds' share of overall participants grew from 26% to 68% over the same period. Fidelity represents about 20% of the retirement-fund market.

A Fidelity survey of employers also found that nine out of 10 that are considering a change in default option expect to switch to a lifecycle plan.

Fidelity and Vanguard, its competitor, offer a host of such lifecycle funds. BankingMyWay.com features calculators that estimate how much individuals will need to save for retirement.