Life-Cycle Fund: How They Work, Examples

What Is a Life-Cycle Fund?

Life-cycle funds are asset-allocation funds in which the share of each asset class is automatically adjusted to lower risk as the desired retirement date approaches. As a practical matter, this usually means that the percentage of bonds and other fixed-income investments increases. Life-cycle funds are also known as "age-based funds" or "target-date retirement funds."

A young investor saving for retirement would typically choose a life-cycle fund with a target date that is 30 to 40 years away. However, an investor nearing retirement age might be planning a working retirement with some income from a small business. Such an investor could select a life-cycle fund with a target date that is 15 years in the future. Accepting higher volatility can help to stretch retirement funds over the 20 or more years of old age most individuals can expect.

How a Life-Cycle Fund Works

Life-cycle funds are designed to be used by investors with specific goals that require capital at set times. These funds are generally used for retirement investing. However, investors can use them whenever they need capital at a specific time in the future. Each life-cycle fund defines its time horizon by naming the fund with a target date.

An example will help to explain how a life-cycle fund works. Suppose that you invest in a life-cycle fund with a target retirement date of 2050 in 2020. At first, the fund will be aggressive. In 2020, the fund might hold 80% stocks and 20% bonds. Each year, there will be more bonds and fewer stocks in the fund. By 2035, you should be halfway to the retirement date. The fund would be 60% stocks and 40% bonds in 2035. Finally, the fund would reach 40% stocks and 60% bonds by the target retirement date of 2050.

Benefits of Life-Cycle Funds

For investors with a targeted need for capital at a specific date, life-cycle funds offer the advantage of convenience. Life-cycle fund investors can easily put their investing activities on autopilot with just one fund. The fixed asset allocations of life-cycle funds promise to give investors the right balanced portfolio for them each year. For investors who seek to take a very passive approach to retirement, a life-cycle fund may be appropriate.

Most life-cycle funds also have the advantage of a preset glide path. A preset path offers investors greater transparency, which gives them more confidence in the fund. A life-cycle fund's glide path provides for steadily decreasing risk over time by shifting asset allocations toward low-risk investments. Investors can also expect a life-cycle fund to be managed through the target retirement date.

Criticisms of Life-Cycle Funds

Some critics of life-cycle funds say that their age-based approach is flawed. In particular, the age of the bull market may be more important than the age of the investor. Legendary investor Benjamin Graham suggested adjusting investments in stocks and bonds based on market valuations rather than your age. Building on Graham's work, Nobel Prize-winning economist Robert Shiller advocated using the P/E 10 ratio as a measure of stock market valuation.

Life-cycle funds are based on the idea that young investors can handle more risk, but this is not always true. Younger workers usually have less money saved, and they almost always have less experience. As a result, younger workers are exceptionally vulnerable to unemployment during recessions. A young investor who takes on high levels of risk might be forced to sell stocks at the worst possible time.

Investors might also prefer a more active approach. Those investors should seek a financial advisor or use other types of funds to meet their investment goals.

Real World Example of a Life-Cycle Fund

The Vanguard Target Retirement 2065 Trusts are one example of life-cycle funds. In July 2017, Vanguard launched its life-cycle offering for 2065, the Vanguard Target Retirement 2065 Trusts. The fund offers an example of how life-cycle funds transition their allocations for risk management.

The Vanguard Target Retirement 2065 asset allocation remains fixed for the first 20 years, with approximately 90% in equities and 10% in bonds. For the next 25 years leading to the target date, the allocation gradually moves more toward bonds. At the target date, the asset allocation is approximately 50% in equities, 40% in bonds, and 10% in short-term TIPS. The allocation to bonds and short-term TIPS gradually continues to increase in the seven years following the target date. After that, the allocation is fixed at approximately 30% stocks, 50% bonds, and 20% short-term TIPS.