Targeting Employees Risk Tolerance And Age

The Rise of Lifecycle Funds Targeting Employees Risk Tolerance And Age

By Steve Tuckey

Many money managers are promoting “lifecycle” and “lifestyle” funds that are supposed to ease the burden of investing assets by creating professionally managed portfolios designed for and targeted at investors in specific age groups and risk-preference groups

Is adding a lifecycle fund family to plan investment menus a great way to improve employees results, or is it just another way to make the menus longer?

Most investment experts interviewed agree that lifecycle funds can be great tools for helping employees diversify, but they warn that the funds are no substitute for personalized counsel from a knowledgeable advisor.

“There is more to planning for retirement than picking the year you wish to hit the beach,” says Kerry OBoyle, an analyst at Morningstar.com, an arm of Morningstar Inc., Chicago. “Unlike a financial advisor, [a lifestyle fund] wont tell you if your goal is realistic or if you are saving enough to reach that goal.”

Lifecycle funds fall under 2 main headings: “target-date funds” and “target-risk funds.”

Target-date funds, which usually are named for the year the typical holder intends to retire, are seen as the funds that put the most responsibility in the hands of the managers. The funds in this group require the least investor involvement in that the portfolios are rebalanced at certain specified intervals to match a clients risk tolerance, which is assumed to lessen as the decades go by. Such rebalancing can take place automatically or at the clients initiative at the specified time periods.

Target-risk funds build their allocation around a pre-specified level of risk, and then undergo rebalancing so as to maintain that risk level.

In addition to being convenient to use, many lifecycle funds also are cost-effective. Investment companies such as T. Rowe Price, Baltimore, dont charge anything for putting portfolios together; investors merely pay the expenses of the underlying funds.

Although Fidelity Investments, Boston, says it introduced the first lifecycle fund in 1988, the concept did not really catch on until the late 1990s.

While the concept remains somewhat controversial, lifecycle funds certainly are proliferating.

Between December 2001 and September 2004, target-date and target-risk funds have achieved annual growth rates of 51% and 20%, respectively, compared to an 8% annual growth rate for all long-term assets, according to Ross Frankenfield, an analyst at Financial Research Corp., Boston.

Within the target-date category, Fidelitys Freedom Fund remains the dominant player with 73% of the category assets through September 2004.

Although Fidelity held the lions share of the target-date fund assets, it accounted for only 39% of the third-quarter 2004 net sales, and that demonstrates the increased competitiveness within the target-date fund category, Frankenfield says.

The target-risk category also is becoming more popular. Like the target-date funds, target-risk funds reported $3 billion in third-quarter 2004 net inflow.

Terrence Herr, with Herr Capital Management L.L.C., Chicago, says he recommends the target-date lifecycle funds for clients with retirement plan accounts with less than $100,000 in assets.

“Those are people with 401(k)s who are never going to talk to an advisor,” Herr says. Investing in a target-date fund “makes sense because it automatically diversifies them.”

Herr encourages any client with more than $100,000 to invest in the more hands-on target-risk funds, even if the client prefers not to tinker too much with portfolio management.

Plan members may be happier with the results they get if they base allocation decisions on risk tolerance levels rather than age, Herr says.