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Experts: Don't Forget Your Life-Cycle Equities

The retirement funds are wildly popular, but pay attention to their differences before choosing.
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Life-cycle funds, also frequently referred to as target-date or target-maturity funds, are all the rage right now, and many observers predict they will continue to gain in popularity, particularly as they become a bigger presence in retirement accounts.

But with more than 20 providers of these funds already in the market, and more entering all the time, choosing among them can be a challenge.

"It's a very popular product for fund companies to be offering," says Mark Labovitz, a research analyst with Lipper.

"There is a lot of demand for this product and the marketplace is recognizing it,"says Jerome Clark, portfolio manager for retirement funds at

T. Rowe Price

(TROW) - Get T. Rowe Price Group Report

, a provider of target-date funds. "On a regular basis you're seeing new entrants to this area."

So how should investors and advisers go about picking the right fund?

According to Clark, one of the biggest considerations is a fund's asset-allocation strategy.

There may be several funds geared toward the same investor -- for instance, a handful of products designed for people retiring in 2040 -- but "they can look very different in their asset-allocation strategies," Clark says.

He adds that it is particularly important for investors to make sure they have adequate exposure to equities.

"Not only are individuals living longer, but ... they're living more active lives, which makes it much more critical for them to get it right."

Lipper's Labovitz says that taking your age and subtracting it from 120 was once considered a good rule for deciding what portion of your assets should be in equities. (For instance, a 50-year-old would have 70% of his holdings in equities.) However, he says, recent research shows that that amount of equity exposure might be insufficient for investors' needs.

Labovitz says investors also should consider how many asset classes a fund has, and their composition. "More asset classes is not always better," he says.

By considering factors such as those, says Labovitz, you can determine what the likelihood is that a particular fund will fall short -- in other words, won't be able to meet your needs at retirement -- and that, he says, is paramount in choosing the correct life-cycle fund.

Among the other factors that experts say investors should be mindful of when selecting a life-cycle fund are whether the product has an appropriate level of diversification among different asset classes, the performance of the fund itself, the risk ratio and, of course, fees and expenses.

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Further Study

Spurred by the proliferation of life-cycle products, California-based Turnstone Advisory Group recently released a study that looked at many of those factors to assess and rank the six largest providers of such funds.

The fund families examined were

Fidelity

,

Vanguard

, T. Rowe Price,

The Principal Group

,

Barclays Global Investors

and

Wells Fargo

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.

Together, these companies manage more than 90% of assets in target-date funds, according to the study, which was conducted by Joseph Nagengast of institutional consulting and portfolio management firm Turnstone; John Bucci of investment management firm The Gurtin Group, a division of

Morgan Stanley

; and William Coaker of the San Francisco Employees Retirement System.

Each family was evaluated based on structure and strategy, expenses, allocation, performance and risk -- both modern portfolio risk -- an investment strategy that uses diversification to control risk -- and upside/downside risk. The factors were weighted differently to come up with a total maximum score of 100.

Here's what the study found: Principal Investors LifeTime Funds took the top spot, earning 81 points. Next came Vanguard Target Retirement Funds, which scored a 77, Fidelity Freedom Funds, which came in with 75 points, T. Rowe Price Retirement Funds, which earned 74 points, Barclays Global Investors LifePath Funds, which scored a 66, and Wells Fargo Outlook Funds, which finished with 61.

All of the fund families earned the same rating -- four points out of five -- in terms of their structure, which looked at factors such as philosophical approach to investing. For instance, do the managers use a fund-of-funds structure and are the funds managed more actively or passively?

Many of the other metrics, though, varied significantly.

On the expense side, Vanguard topped the charts, scoring the maximum of 15 points, while Wells Fargo had the lowest score, seven points. For their allocation strategy, Principal and T. Rowe Price received the highest marks (both scoring 15 out of 20 points), while Vanguard lagged with 13.

For performance, Principal scored 27 points out of 30, trumping the 19 points earned by last-place finisher Wells Fargo. As for risk assessment, Principal earned 27 points out of 30, while Wells Fargo came in last again, scoring just 18 points. (Modern portfolio risk measures and upside/downside risk were worth 15 points each in the study.)

The authors also reached some interesting conclusions about the overall group.

"We have been pleasantly surprised to learn that most fund families of life-cycle funds are, in fact, producing near market-like returns for their longer-horizon fund investors in up markets and protecting assets for their shorter-horizon fund investors in down markets," the study said.

The study also found that returns for funds with the same target date were very similar, even among funds using widely different investment strategies.

One concern, however, was expenses. With the exception of the Vanguard Target Retirement Funds, the authors maintain that much more could be done to drive down the cost of the products examined in the study. (The mean expense ratio of the life-cycle funds examined was 71 basis points.)

"The underlying structure of most of the funds is ready-made for a very low weighted expense ratio. Most employ quantitative or index-based allocation strategies and should not be charging a premium," the authors said.

They added, "We challenge these major fund families to provide more competitively priced funds. Pass those low cost structures on to the end investor in the form of lower expense ratios and higher returns."

Another issue raised was that most of the managers of the funds studied add diversification by relying on the low correlation between U.S. stocks and bonds. That could be an issue in the future if stock and bond markets become more closely correlated.