What are life cycle funds?

Life cycle funds

Have you heard of life cycle funds? Sometimes called target retirement funds or age based funds, they are essentially the “set it and forget it!” of mutual funds.

Like other mutual funds, these life cycle funds are comprised of a mix of stocks and bonds of various levels of risk. Typically with mutual funds (or any investments) you pursue higher risks when you are young and have plenty of time to recover from losses. Then as you approach retirement, you gradually move your money to lower risk investments, such as government bonds.

Here’s an example: A diversified young person in the beginning of their career might have 80% invested in high risk funds and 20% in low risk. Somewhere around midway to retirement these percentages approach 50/50 and by the time you retire the ratio should be inverted to 20% (or less) high risk and 80% low risk.  (Note: These percentages are meant to be examples, not hard and fast rules. In fact, although these are the traditional percentages I grew up learning from my grandfather, I’m not sure I intend to follow them. But alas, a different post for a different day)

In this traditional example, you have to keep in mind what diversity you would like to see in your portfolio and update your investments every 5-10 years.  Now that’s not very often, so for many people this is not a big deal.

But the great thing about a life cycle fund is that it automatically adjusts the ratio of your investments as you approach retirement. This is great for people who are overwhelmed with deciding where to invest their money and appreciate the automaticity.  All you have to do is choose the life cycle fund that closely matches the year you wish to retire and the fund gradually shifts to more and more conservative funds as that date approaches.

Life cycle funds are available through many investment brokers, such as USAA and Vanguard, and they are also an option for your TSP under the category of L funds, available as a Roth or traditional. We have our Roth TSP invested in the life cycle funds.

The drawback of life cycle funds (and you knew there had to be one!) is they tend to have a high expense ratio. An expense ratio is the percentage that the brokerage firm charges (takes, really) as their fee. For example, Vanguard charges about 0.40% – 0.50% for their various life cycle funds (as seen here). In comparison, their index funds run from 0.05%-0.09%. This might be a little like comparing apples to oranges, but this article does a great job explaining how you could basically create your own Vanguard Target Retirement Fund with Vanguard funds and much fewer expenses.

The exception to this higher expense ratio is the TSP. The TSP charges 0.029% for all of their various funds (the C fund is 0.028%, an insignificant difference in my opinion). So in the case of TSP you can use a life cycle fund (the L funds) as an easy way to not manage your retirement investment AND not pay any additional expense ratios.

What do we do here at the F&F house? For our Roth IRAs, we felt that the expense ratios were just too high and we decided to manage our own portfolios and diversify on our own. But for the TSP, we decided to select the L funds and let the account managers make those decisions since we would be charged the same anyways.

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