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The Morphing Of Mutual Funds In The Retirement Arena

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Insurance products are not the only financial vehicles that set confusion wheels a-spinning. So do retirement-minded mutual funds that have names like lifecycle, target date, retirement date, retirement income and payout mutual funds.

In general, these products manage asset class mixes in a way that makes the portfolio progressively more conservative over time, or that enables the investor to move easily into increasingly conservative funds in a fund family as retirement nears.

The funds are part of the burst of products that have been unveiled, all seeking to help the older set with their retirement financials. As such, they are welcome additions to the tried-and-true funds of yesteryear–stock, bond, etc.

But it’s tricky figuring out how these new products differ, and what to expect of them long term. Let’s unpack this.

Their genesis seems to be the “lifestyle” funds that, according to NU archives, first took wing in the late 1980s. The lifestyle funds offered premixed allocations and investment goals designed for various life stages, such as young professionals, families with young kids, and so on.

By the mid- to late-1990s, the “lifestyle” notion of matching allocations to needs and goals morphed–into “lifecycle” funds. These were funds-of-funds, typically offered inside of 401(k) plans. Then, as now, the providers promised to adapt investment strategy and choice according to a participant’s age and retirement goals.

Originally, the lifecycle and lifestyle funds seemed nearly the same; but their descriptions and positioning were not. The lifecycle funds aimed at correlating with stages in life, not style of life.

By the early 2000s, the lifecycle funds had developed discrete versions–the target- or retirement-date funds, and the target-risk funds. The former focus on automatic rebalancing to more conservative allocations as the specified retirement date draws near, while the later seek to align with the investor’s risk tolerance (conservative, aggressive, etc.), much as the lifestyle funds had done.

In recent months, the industry has morphed these concepts yet again–into “payout” or “retirement income” funds.

In these newest products, fund managers allocate assets in such a way that, by time the person is ready to take retirement income, the fund should be able to make annual payouts (via withdrawals made by the investor) of some targeted amount. The target withdrawals might be, say, 3% to 6% or more of fund value, or some type of “level” as set out in the product materials. The payouts aren’t guaranteed, but they are presented as the intended goal. (See an article on payout funds by NU Senior Editor Jim Connolly in the June 2008 issue of Income Planning, an e-newsletter of NU.)

There is a whole lot to like about all these fund types. Most of all, they take the burden off of the consumer to set up an allocation, manage the allocation (or keep eye on the quarterly rebalancing program) and otherwise make investment decisions which they do not feel qualified to make.

But, as indicated earlier, a few cautionary notes are in order:

o These products are relatively new, so they do not have lengthy track records to which retirement income advisors can refer. This injects uncertainty into use of the products, an uncertainty which is at odds with their goal of making retirement planning less burdensome.

o The product categories differ from one another. For instance, as indicated above, a target-date fund is not the same as a payout fund. Also, the investment strategy used by funds in each category may differ, with one weighted more or less toward equities than another (researchers Watson Wyatt and FRC have both found such variety in target-date funds.) This is not surprising; these are mutual funds, after all. But, because the funds are positioned for retirement and because some funds even set specific dates in their names, the ill-informed may unwittingly infer a similarity and a predictability that is just not there.

o These products are not guaranteed. They are not annuities or bank certificates of deposit. They are investments, and the fund values can fluctuate not only with market conditions but also with choices made by the fund managers, account activity, and other factors that affect mutual fund performance in general.

The intrigue–and the confusion–don’t stop there. A few insurers have started offering, or plan to offer, income guarantees, using annuities, with some of these funds. This will address the “no guarantees” problem cited earlier, but it will likely also make people wonder, “what is this–a mutual fund or an annuity?”

It could be that, in the retirement arena, mutual funds and annuities will keep on morphing toward one another. This will put the onus on advisors to keep consumers up to speed–and clear of problems.


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