Retirement Date Funds are known by a couple of different names such as age based funds, life cycle Funds, etc., but they are all based on the same idea that the fund (either mutual fund or ETF) will reallocate itself based on the chosen retirement date.  They are meant to be a maintenance free and thought free way to passively reallocate over time.

For most they are probably a fantastic way to invest in the market knowing someone else is worrying about allocation, however, for me they just don’t make all that much sense.

Comparing Two Life Cycle Funds from the Same Company

I think the easiest way to understand the concept is to take a look at two funds from the same company, Vanguard.

Vanguard Target Retirement 2045 Fund (VTIVX)

Portfolio composition – Allocation to underlying funds as of 08/31/2013

Ranking by Percentage Fund Percentage

  1. Vanguard Total Stock Market Index Fund Investor Shares 63.0%
  2. Vanguard Total International Stock Index Fund Investor Shares 26.8%
  3. Vanguard Total Bond Market II Index Fund Investor Shares† 8.2%
  4. Vanguard Total International Bond Index Fund Investor Shares 2.0%

Total — 100.0%

Vanguard Target Retirement 2015 Fund (VTXVX)

Portfolio composition – Allocation to underlying funds as of 08/31/2013

Ranking by Percentage Fund Percentage

  1. Vanguard Total Stock Market Index Fund Investor Shares 37.1%
  2. Vanguard Total Bond Market II Index Fund Investor Shares† 32.4%
  3. Vanguard Total International Stock Index Fund Investor Shares 15.9%
  4. Vanguard Total International Bond Index Fund Investor Shares 9.4%
  5. Vanguard Short-Term Inflation Protected Securities Index Fund Investor Shares 5.2%

Total — 100.0%

A quick look at the allocation you can see the differences.  The person retiring in 2 years has a higher allocation towards “safer” investments.  Bonds are 41.8% vs. 10.2% and Short term Inflation Protected Securities are at 5.2% vs. 0%.  The idea is that as we get closer to the 2045 date it will look more like the 2015.

Wait so someone else does the work, why isn’t this a good thing?

Why I am not a big Proponent of Life Cycle Funds

Doesn’t take into account Current Market

Selling out of the stock market and getting into bonds should be a bigger decision than just hitting a date.  For example, if you sold out of the market today and jumped into a bond fund it could have disastrous results if you believe interest rates are set to rise over the next couple years.

Age Based Funds are Expensive

Since they are traditionally a fund of funds you are not only paying the expenses on the fund you buy into but the funds it holds as well.  With the low fees at Vangaurd you are probably way ahead anyway when compared to other investing options, but that may not be true across the board.  For instance the Vanguard 2020 Retirement fund has an expense ratio (not including the funds it holds) of .16% while the Fidelity 2020 Fund has an expense ratio 4x that amount at .65%.

There is No Uniform Allocation

There are no uniform allocation rules (nor should there be), but this may be a problem for the investor purchasing the investment.  This isn’t the fault of life cycle funds themselves, per se, but rather the individual investor.  Lets stick with the Fidelity 2020 vs Vanguard 2020:

Vanguard Portfolio composition as of 08/31/2013

  1. Vanguard Total Stock Market Index Fund Investor Shares 43.6%
  2. Vanguard Total Bond Market II Index Fund Investor Shares† 30.3%
  3. Vanguard Total International Stock Index Fund Investor Shares 18.5%
  4. Vanguard Total International Bond Index Fund Investor Shares 7.6%

Versus

Fidelity 2020:

  1. Equity Funds – 35.31%
  2. Commodity Funds – 5.61%
  3. International Equity Funds – 14.49%
  4. Bond Funds -37.37%
  5. Short-Term Funds & Net Other Assets – 7.22%
  6. NET OTHER ASSETS -0.07%

The two “similar funds” have different allocations.  Vanguard has 62.1% in Equities while Fidelity is 49.8%.  Those are very different risk tolerances for people retiring in 2020.   Again this isn’t the fault of the fund, but of investors who need to understand what they are buying and a lot of people just don’t.

Would I Put a Friend or Family Member into a Life Cycle Fund?

Absolutely.  How do I reconcile my feelings? If they don’t want to get involved in reallocating themselves then the above negatives are outweighed.