Most people are devotees of some hobby outside of work -- for me, it's movies. For others, it's Oscar Wilde, or numismatics. Maybe ornithology. I don't know of anyone whose non-professional passion is asset allocation. No one I know enjoys a lost weekend watching an asset-allocation marathon. They don't huddle inside a coffee house and discuss efficient frontiers and debate whether we have witnessed the death of the equity-risk premium. It's just not that much fun.
Therein lies the problem: Most people, out of fear, confusion or inertia, manage to avoid asset allocation their entire lives. Studies have shown that the average investor allocates 401(k) assets once -- or defers to whatever classes his or her employer provides as as a default -- and never adjusts or rebalances the portfolio again.
"Most investors don't do anything because they have too many choices, and they don't always understand them," said Richard Thaler, behavioral finance professor at the University of Chicago.
What's an inert, asset allocation-averse investor to do? Good news: The fund industry, in its wisdom, offers "lifestyle" funds. While they vary, these funds essentially act as one-step lifetime asset allocators -- setting up a basket of stock, bond and cash mutual funds to meet your needs, according to one's age and risk tolerance. We'll discuss how to use them and name a few that might be best for you.
Let me be clear: These funds aren't the optimal choice-diversified portfolio. In the coming week, I'll devote a few columns to more sophisticated and successful strategies. But this is the easiest asset-allocation deal out there, and I guarantee it offers exponentially greater returns than inertia.
"Overall, these types of funds are a good tool for investors to use vs. doing nothing," said Scott Majeski, senior consultant at Ibboston Associates in Chicago. "If you don't do anything else, using this fund is the next best alternative." That may sound like faint praise, but since most people do nothing, this is a great solution.
"This is a smart option for unsophisticated investors who aren't working with a financial planner," said Cynthia Meyers, a certified financial planner in Sacramento, Calif. Meyers said she doesn't typically use lifestyle funds unless a client's 401(k) plan doesn't offer more viable alternatives. "It's a good solution for people who have inadequate 401(k) plans." These funds are also an option for investors who lack the ready money to achieve diversification by buying different fund classes -- buying, say, five funds with a $2,500 minimum apiece makes it tough for some folks just getting started.
The Keys to Using Lifestyle Funds
I'll get to the specific options in a second -- I don't want to lose those inert folks out there -- but there are a few things investors need to know about how to best use lifestyle funds.
Don't use them in tandem with other funds.
The value of these funds is that they offer one-stop asset allocation, as in 60% stocks (domestic large-cap, small-cap and foreign), 30% bonds and 10% cash for the moderate investor. If an investor chooses one lifestyle fund and one large-cap stock fund, for instance, you lose the balanced portfolio that the lifestyle funds offer.
Keep an eye on expenses.
"You always want to look at the price," Meyers said. The expense ratio on a lifestyle fund shouldn't be any higher than the average mutual fund. Also, some fund firms tack on extra fees to assemble the lifestyle funds for you. If you can't figure it out from the prospects, call the company and ask.
These funds, as the name suggests, are designed to fit a particular lifestyle -- not just how far you are from retirement age, but also your investment temperament.
"Investors really need to know how much risk they can handle -- you shouldn't put your money in an aggressive growth lifestyle fund if it means you can't sleep at night," Meyers said. Firms generally offer four or five funds -- for the conservative to the aggressive-growth investor.
"Investors can't be absolved from doing the initial work to decide what angle works for them," said Langdon Healy, a mutual fund analyst at Morningstar. Meyers said the middle-of-the-road choice -- moderate growth, with a usual mix of 60% stocks, 30% bonds and 10% cash -- is a good bet for most investors who have a ways to go before retiring.
Lifestyle funds aren't designed to beat the market, giving you hot returns and bragging rights at a party with your friends. If you really want that, good luck and God bless -- but know you have to put more work into it. If you want to choose and go away for 30 years (except to check your holdings, say once a year, with some of these options) and end up getting an average annual return of about 7% or so, these are your best bet.
Here's a look at three of the best lifestyle fund series.
1. Fidelity Freedom Series
Fidelity offers five Freedom funds with a year as part of the name, such as the Fidelity Freedom 2020 fund. Investors typically choose the fund whose date most closely corresponds to their retirement date. Fidelity achieves your proper asset allocation by choosing a blend of their own funds. The Freedom 2020 fund, for instance, has 18 funds under its hood, working out to a mix of about 63% stocks, 31% bonds and the remainder in cash and other investments.
Here's the great thing about these funds: "Fidelity takes it upon itself to change the allocation, making it increasingly more conservative as the date approaches," Morningstar's Healy said. Because Fidelity rebalances the funds for you over the course of your investment lifetime, these offerings are probably best for the investor who wants to never pay attention to the markets and asset allocation again.
Fidelity tacks on a fractional additional expense for picking the funds for you, but 0.07% shouldn't be enough to keep you away.
2. Vanguard LifeStrategy Series
The Vanguard LifeStrategy series has plenty of selling points, too. First off, it categorizes the funds into four simple choices: Growth, Moderate Growth, Conservative Growth and Income. It's pretty straightforward -- the growth fund has 75%-80% of its assets in stocks; the income fund has about 80% in bonds and cash. Another highlight for these funds: the price. Because Vanguard primarily uses its low-cost index funds and doesn't add an additional fee, your expenses are extremely low.
The downside with Vanguard's LifeStrategy series: They don't allocate for you. Your portfolio remains static, unless you rebalance yourself. "Investors need to check at the end of every year to determine if their asset-allocation needs have changed," said Ibbotson's Majeski.
3. T. Rowe Price Retirement Series
Like the Fidelity series, T. Rowe Price's offerings are labeled by a year: 2010 up through 2040 -- and they rebalance for you over the course of your investment lifetime. The T. Rowe Price Retirement Income fund is similar to Fidelity's Freedom Income offering, except it's a little less conservative -- a nearly 40% stock weighting, compared to Fidelity Freedom's 17%.
Like the Vanguard series, the T. Rowe series doesn't levy any additional fees -- only an averaged-out fee of all the funds the lifestyle fund holds.
Like Fidelity and Vanguard, T. Rowe's series makes for a good bet because the firm behind it has the heft to offer quality offerings across all asset classes. T. Rowe Price is a stellar shop, so the inert investor is in good hands.
Other fund firms offer variations of lifestyle funds. If investors are lucky enough to have employee-retirement plans that offer a luxury of choices, they need to make sure that they go with a firm like the three above that have the ability to offer a wide range of stellar funds.
Lifestyle funds aren't for everyone, but they're much better than nothing -- and they give you more time to do what you really love.