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    Allocation Over Time: Life Cycle Mutual Funds

    by John Markese

    Allocation Over Time: Life Cycle Mutual Funds Splash image

    What time is it in your life cycle?

    That’s a key question in the asset allocation decision, because investment objectives—which drive the asset allocation decision—change over one’s lifetime. That means that investors are faced not only with the complicated issue of how to allocate assets at one point in time, but also how to change that allocation over time.

    Too complicated?

    Enter life cycle funds, designed to provide investors with an all-in-one “lifetime” package.

    The Life Cycle Concept

    Life cycle funds go by many names—strategic allocation, asset manager, personal strategy, life strategy, target retirement—but the common theme is that they offer specific asset allocations and investment selections for specific investment objectives—all bundled up in one fund.

    Some funds parse the investment objective into levels of risk tolerance with conservative, moderate and aggressive portfolios.

    Other life cycle funds divide investment objectives into target retirement dates and simply assume that investors move over the continuum from aggressive to conservative as retirement approaches—and on to an income objective after retirement.

    Life cycle funds also approach their investment task of asset allocation in different ways. Some maintain a relatively fixed asset allocation through time, while others are actively managed and specify ranges for asset categories that can be broad, implementing changes based upon forecasts.

    Funds that have target retirement dates often specify initial asset allocations and target date allocations, systematically moving from the former to the latter.

    How these various life cycle funds invest in the asset categories is also varied. Some of these funds invest in individual stocks and bonds to populate the asset categories, while others are funds of funds, investing in a portfolio of individual funds—some or all of which may be unmanaged index funds, while some might be combinations of index funds with fixed allocations and funds with variable allocations.

    The irony has probably not escaped you: You are invested in a life cycle fund for its simplicity, but due to the layered complexity of your life cycle fund choices, your investment task appears far from simple. The financial sword you need to cut all the way through this Gordian knot of life cycle fund choices is forged from life cycle fund information, sharply organized.

    TABLE 1. Life Cycle Funds
    Fund Family Fund Ticker Return Yield
    (%)
    Total
    Risk
    Index
    Expense
    Ratio*
    (%)
    YTD
    (%)
    3Yr
    (%)
    5Yr
    (%)
    Active Funds
    American Strategic Alloc Aggressive TWSAX 2.2 6.5 4.5 0.8 0.74 1.2
    Century Strategic Alloc Moderate TWSMX 2.1 6.4 5 1.2 0.59 1.1
    Strategic Alloc Conservative TWSCX 2.3 5 5.2 1.4 0.4 1
    Fidelity Asset Manager Growth FASGX -1.2 4.2 0.6 2.1 0.91 0.83
    Asset Manager FASMX -0.1 4.8 3.3 1.7 0.66 0.74
    Asset Manager Income FASIX 1.9 6.2 4.7 1.8 0.32 0.61
    T. Rowe Price Personal Strat Growth TRSGX 4.5 8.7 4.6 1.1 0.83 1
    Personal Strat Balanced TRPBX 4.1 8.5 5.4 1.8 0.64 0.86
    Personal Strat Income PRSIX 3.6 7.6 5.9 2.3 0.44 0.75
    Fixed-Allocation Funds
    Schwab MarketTrack All Equity SWEGX 1.9 6.4 0.1 0.9 1.07 0.5
    MarketTrack Growth SWHGX 2 6.1 1.6 1.3 0.84 0.5
    MarketTrack Balanced SWBGX 2.2 5.9 3 2 0.61 0.5
    MarketTrack Conservative SWCGX 2.6 5.7 4.3 2.7 0.4 0.5
    Vanguard LifeStrategy Growth VASGX 2.6 6.7 1.5 1.7 0.89 0
    LifeStrategy Moderate Growth VSMGX 2.8 6.5 3.1 2.2 0.68 0
    LifeStrategy Conservative Growth VSCGX 2.6 5.8 4.3 2.6 0.47 0
    LifeStrategy Income VASIX 2.7 5.3 5.5 3.2 0.3 0
    Transition Funds
    Fidelity Freedom 2040 FFFFX 0.9 6.1 na 1.2 0.99 0.08
    Freedom 2035 FFTHX 1 na na na na 0.08
    Freedom 2030 FFFEX 1 6 1.2 1.3 0.88 0.08
    Freedom 2025 FFTWX 1 na na na na 0.08
    Freedom 2020 FFFDX 1.2 6.1 2.3 1.7 0.74 0.08
    Freedom 2015 FFVFX 1.4 na na na na 0.08
    Freedom 2010 FFFCX 1.5 5.6 3.7 2.1 0.47 0.08
    Freedom 2005 FFFVX 1.5 na na na na 0.08
    Freedom 2000 FFFBX 1.4 4.1 4 1.7 0.25 0.08
    Freedom Income FFFAX 1.3 3.6 4.2 2 0.2 0.08
    T. Rowe Price Retirement 2040 TRRDX 2.8 na na 0.7 na 0
    Retirement 2035 TRRJX na na na na na na
    Retirement 2030 TRRCX 2.9 na na 0.7 na 0
    Retirement 2025 TRRHX na na na na na na
    Retirement 2020 TRRBX 2.9 na na 0.8 na 0
    Retirement 2015 TRRGX na na na na na na
    Retirement 2010 TRRAX 2.8 na na 0.9 na 0
    Retirement 2005 TRRFX na na na na na na
    Retirement Income TRRIX 2.2 na na 2.4 na 0
    Vanguard Target Retirement 2045 VTIVX 2.5 na na na na na
    Target Retirement 2035 VTTHX 2.7 na na na na na
    Target Retirement 2025 VTTVX 2.9 na na na na na
    Target Retirement 2015 VTXVX 2.9 na na na na na
    Target Retirement 2005 VTOVX 3.3 na na na na na
    Target Retirement Income VTINX 3.5 na na na na na

    How They Compare

    In Table 1, the performance statistics of life cycle funds are given with the funds grouped in categories by fund asset allocation approach—active, fixed allocation, and transition.

    Active Funds
    The active life cycle funds have a few elements in common. All have fund offerings that are titled on the continuum from aggressive to conservative or growth to income and have at least three funds. These active life cycle funds invest in individual securities, whether stocks or fixed-income investments, rather than other mutual funds.

    But why they are saddled with the term ‘active’ is the real story. If you read the prospectus of any of these funds—and you should before investing—you’ll find that they give a long-term strategic target asset allocation but also designate rather wide ranges for the asset categories (money market investments from 0% to 15%, for example). Basically, the portfolio manager will actively vary the asset allocation mix based upon their forecast of how well the various asset classes will perform relative to each other over some undefined period of time. In other words, these active life cycle funds provide asset allocation, security selection and market timing services.

    This latter activity presents some problems, as illustrated in Table 2. The active allocation approach may make it difficult to pinpoint an appropriate life cycle fund choice.

    For example, the Fidelity Asset Manager Growth Fund has a target stock allocation of 70%, with a range of 50% to 100%. At 50% stock this would hardly be a growth fund, and at 100% stock it would certainly be aggressive. It is only a dream that this fund—or any fund—would be at the maximum of the range for stocks just as the market was entering a bull phase, or at the minimum stock allocation as the market was entering a bear phase.

    There are two crucial decisions for investors in fund groups that have a continuum of growth-to-income and aggressive-to-conservative funds: First, you have to decide which fund to start out with; and second, you have to decide when to jump to another as you move through your cycle of life. All trade off risk and return, capital appreciation and income:

    • The higher risk growth/aggressive fund portfolios are for investors with longer horizons or more tolerance for risk, variation in return and fund value.

    • The lower risk income/conservative funds are for investors with shorter horizons or less tolerance for risk.
    Both Fidelity and Vanguard have very useful tools, such as risk assessment questionnaires, on their Web sites (go to www.fidelity.com for Fidelity and www.vanguard.com for Vanguard) to help you in your asset allocation fund choice. Is it the aggressive allocation in your youth, the moderate in middle age and the conservative fund into retirement and beyond?

    Again, not so simple a decision. As your risk attitude changes, so should your life cycle fund choice. But it is not quite so easy to take your risk temperature. Wealth, health, family, employment and retirement plans can all affect your risk temperature. Quiz yourself annually on what’s most important—capital preservation, income, wealth accumulation. It won’t happen overnight, but you will know when to move down the risk ladder. Trust your financial instincts. As a caution, remember that unless this type of fund is in a tax-sheltered account—i.e., IRA, 401(k), 403(b), Keogh, SEP, etc.—it is a potentially significant tax event to switch from one fund to another.

    TABLE 2. Active Life Cycle Fund Asset Allocations
    Fund Family Fund Stock Bond Money Market
    Target
    (%)
    Range
    (%)
    Target
    (%)
    Range
    (%)
    Target
    (%)
    Range
    (%)
    American Strategic Alloc Aggressive 78 60–90 20 10–30 2 0–15
    Century Strategic Alloc Moderate 63 53–73 31 21–41 6 0–15
    Strategic Alloc Conservative 45 39–51 45 38–52 10 5–20
    Fidelity Asset Manager Growth 70 50–100 25 0–50 5 0–50
    Asset Manager 50 30–70 40 20–60 10 0–50
    Asset Manager Income 20 10–30 50 40–60 30 10–50
    T. Rowe Price Personal Strat Growth 80 70–90 20 10–30 0 —
    Personal Strat Balanced 60 50–70 30 20–40 10 0–20
    Personal Strat Income 40 30–50 40 30–50 20 10–30

    Fixed-Allocation Funds
    The next category of life cycle fund is the fixed-allocation fund of funds group. Table 3 gives the breakdown of asset allocation for the two groups, Vanguard LifeStrategy and Schwab MarketTrack funds. Schwab employs all index funds in these portfolios: large-cap index, small-cap index, international index, and bond market index.

    Interestingly, Vanguard, a leader in indexing, uses two funds in their mix that are not index funds: Vanguard Asset Allocation Fund and the Vanguard Short-Term Corporate Fund. The asset allocation fund is something of a wild card in the LifeStrategy group because it is actively managed. For example, the LifeStrategy Growth Fund has 25% allocated to the Vanguard Asset Allocation Fund along with 50% to the Total Stock Market Index Fund, 15% to the Total International Index Fund and 10% to the Total Bond Market Index Fund.

    The Vanguard Asset Allocation Fund, managed outside of Vanguard by Mellon Capital Management, can change the proportions of the three asset classes (stocks, bonds, money-market securities) in the fund at any time based upon the portfolio manager’s return expectations, according to the prospectus. And the portfolio manager reserves the right to invest 100% in any of the three asset classes. So 25% of the Vanguard LifeStrategy Growth Fund could be in motion at any time, which further complicates any attempt to get a true fix on the fund’s overall allocation.

    With fund-of-funds formats, there is always a question of fund expense on top of fund expenses. The Schwab MarketTrack funds individually charge a 0.50% expense ratio, capped, on top of the expenses of the underlying funds. The Vanguard LifeStrategy funds do not charge a separate expense ratio, and the underlying funds have a weighted expense ratio of 0.28%. Even though Schwab is employing all index funds in their MarketTrack funds and Vanguard is using a mix of index and actively managed funds, the Schwab MarketTrack funds can be expected to have a higher total annual expense ratio of about 0.50%—a substantial long-term difference.

    TABLE 3. Fixed-Allocation Life Cycle Funds
    Fund Family Fund Asset Allocation
    Stock
    (%)
    Bond
    (%)
    Money Market
    (%)
    Schwab MarketTrack All Equity 100 0 0
    MarketTrack Growth 80 15 5
    MarketTrack Conservative 40 55 5
    Vanguard LifeStrategy Growth 80 20 0
    LifeStrategy Moderate Growth 60 40 0
    LifeStrategy Conservative Growth 40 40 20
    LifeStrategy Income 20 60 20

    Transition Funds
    The final group of life cycle funds, called transition funds, are summarized in Table 4. To compare the asset allocations of the Fidelity Freedom funds to the Vanguard Target Maturity funds and the T. Rowe Price Retirement funds against each other, a long target year, an intermediate target year, and the final income funds (that these target years transition to) are given.

    Here is how they work: All these fund families’ target date funds become increasingly conservative—lower risk, more income, less equity, more fixed income, more domestic stock, less international—over time.

    Five to 10 years after the target retirement date, Vanguard’s and Fidelity’s funds will have fully transitioned into income funds—Fidelity’s Freedom Income Fund, Vanguard’s Target Retirement Income Fund.

    In the case of T. Rowe Price, 30 years after the retirement target date each fund will have transitioned to a position of 20% in stock and 80% in fixed income.

    While the asset allocations of these three transition life cycle funds are very similar (see Table 4) and they all transition to similar stock/bond positions, the individual investment approach for each fund is quite different:

    • The Vanguard Target Retirement 2035 Fund invests in four index funds;
    • The Fidelity Freedom 2035 Fund invests in 18 actively managed funds; and
    • The T. Rowe Price 2035 Fund invests in nine actively managed funds and one index fund.
    Most likely, the actively managed Fidelity and T. Rowe Price funds will trade more than Vanguard’s index funds and will incur more transaction costs, brokerage fees and a spread between the bid and the asked of security prices that reduce total returns. These fund families’ retirement funds also do not directly charge expenses, but incur the weighted expenses of the funds they hold.

    For Vanguard, the estimated 2035 fund expense is 0.23%, for the Fidelity Freedom 2035 the combined weighted total annual expense ratio is 0.90%, and for the T. Rowe Price 2035 fund the weighted expense ratio is 0.88%. Total returns are net of transaction costs and expense ratios. High transaction costs and expenses reduce shareholder returns.

    Which Approach Is Best?

    If you have gotten this far, you probably have read the article carefully and scrutinized all the numbers in all of the tables, but are still contemplating the initial question that drew you to an article on life cycle funds in the first place: Which life cycle fund approach is best for you?

    TABLE 4. Transition Life Cycle Funds
    Fund Family Fund Asset Allocation
    Stock
    (%)
    Bond
    (%)
    Money Market
    (%)
    Fidelity Freedom 2035 85 15 0
    Freedom 2015 61 35 4
    Freedom Income 22 40 38
    Vanguard Target Retirement 2035* 80 20 0
    Target Retirement 2015* 50 50 0
    Target Retirement Income 20 75 5
    T. Rowe Price Retirement 2035 90 10 0
    Retirement 2015 71 26 3
    Retirement Income 40 30 30

    Here’s some help:

    • If you are comfortable with asset allocations that may vary, you have confidence that changing allocations in response to anticipated market trends will improve performance and you prefer to pick a fund profile (aggressive, moderate, or conservative) and change funds when you slip into another profile (but don’t forget tax implications), then an active life cycle fund may be your best choice.

    • If you want a relatively constant allocation but you prefer to select and change from one fund profile to another when your personal circumstances change, then a fixed-allocation life cycle fund may be your best choice.

    • If you do not want to select a fund profile, you are comfortable with selecting an estimated retirement date and your final, in retirement, portfolio objective is income, then the target date, transition life cycle funds may be your best choice.

    Which Fund Is Best?

    Once you select the life cycle approach with which you are most comfortable, including the choice of active management versus index fund, then the next decision you must make is the individual fund or fund family choice. Table 1 details returns for each fund for various periods. Needless to say, you certainly should look at each fund’s performance. But you should also keep an eye on the total risk index. The risk index compares each fund to all other funds based upon variability of returns. A risk index of 1.00 implies average risk, while a risk index of 1.50 would indicate 50% higher risk than the average fund and a risk index of 0.50 would denote a fund with only 50% of the average fund’s risk. Compare conservative funds to conservative funds, aggressive to aggressive, income funds to income funds, and similar target maturities to each other.

    What else should you look for? Expenses are reflected in past returns, but going forward, returns are not predictable while expenses are certain. So, if you can’t make up your mind over two similar funds, opt for the one with lower expenses. Note that the expense ratios listed in the table do not reflect the expense ratios of the underlying funds for fund-of-funds investments.

    Most investors have been around long enough to know that not much in life is simple. And that includes the selection process for life cycle funds.

    But it should not take a life cycle to figure out. Just take a few moments to familiarize yourself with the approaches—study the allocations and risk and return numbers. And ask yourself a few simple questions. Why is it that the simple questions are often the most difficult to answer?


    John Markese is president of AAII.

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