 Personal Finance PowerPoint Presentation Lifecycle Fund Prepare to get financially fit by practicing personal finance. Support Accounting Instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again click the link below for a free month membership to our website and all the content on it. Most of this information comes from Investopedia Lifecycle Fund which you can find online. Take a look at the references. Resources continue your research from there. This is by James Chen, updated May 12, 2022. In prior presentations we've been taking a look at investment goals, strategies, tools, keeping in mind the two major categories of investments that being the fixed income, typically the bonds, the equities, typically the common stock. Also thinking about other tools we might be using such as mutual funds, ETFs possibly helping us to better diversify with less of an upfront investment as opposed to investing in individual stocks, individual bonds. Keeping that in mind, we're now asking what is a life cycle fund? Life cycle funds or asset allocation funds in which the share of each asset class is automatically adjusted to lower risk as the desired retirement date approaches. So now we've got a fund which we're going to think about a mutual fund typically. So remember our strategies as an individual investor. We could be investing in stocks and bonds individually, but it's often useful to use tools such as mutual funds or ETFs. So we put money into those which are going to be pooling with other investors, the fund manager, then allocating those investments over different securities in accordance with the type of fund that has been chosen. Also remember that if you have something like a 401k plan or an IRA, then you don't want to think about them as something really separate than the normal tools of investments like a mutual fund. You might have a mutual fund like this, for example, under the umbrella of a retirement plan which has added tax components to it. And that's how I would kind of think about those components as well. Once we think about the mutual funds, then the question is, do I want to have one very broad mutual fund that's going to try to meet all of our needs or do I want to have multiple mutual funds so that I have a little bit more leeway in terms of how much I want to put into each category, for example. This would be an idea here, the life cycle fund, and this would be a fund that you might use for something like a retirement plan or something like that where you have a target date, possibly retirement. And then as you get closer to the target date, you have a remixing of the fund because as we invest, typically the major factors that are going to involve the optimal asset mix will include things like how long we have until the fund is going to be expired until we hit the target, the time horizon as they say, and our risk tolerance. As we get closer to that time horizon, we would like to readjust our funds typically to be at an optimal level. We can choose a target fund that does that basically for us in kind of a best practice using the general theories to rebalance as we get close to retirement. So 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. So all those make sense, right? Life cycle, we're going through our life cycle. Obviously, as we do so, we're getting older. So we're going to get towards our age-based funds, meaning it's going to change to be optimized in accordance with our age or target date retirement fund, which makes sense because we're trying to go towards the target. And again, as we get closer to that target, the mix between things like bonds and stocks and more conservative kind of investments, you would think more conservative stuff would go up as you get closer and they need to remix that, and if they could do that automatically and something like this as you get closer, that would be a nice, easy way to invest. So 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 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. So we would expect that if we kind of look for some of the investments that have a higher return as we have the longer time horizons then we're more likely than over those longer time horizons to actualize some of those higher returns even though they also come with more risk. As we get closer to the target date, then we're probably going to want to lean away from the more risky type of investments because we don't want to get caught on the downside right when we need the money or when we're close to the target. So 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. So clearly one of the big reasons to use one would be saving for retirement. However, investors can use them whenever they need capital at a specific time in the future. So you might say for something targeted like your child's tuition or something like that could be another way that we can use these kind of target funds which is a nice easy way to use the targeting metrics that are kind of built into the fund to target something rather than trying to build your own targeting matrix that you would then have to adjust and so on and so forth as you get closer to the target. So 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. So at first the fund will be aggressive in 2020. The fund might hold 80% stocks and 20% bonds. Why? Because stocks you would expect to have more volatility but higher returns and therefore you want to be more heavily weighted if you have a longer time horizon in the stocks typically. Each year there will be more bonds in fewer stocks. Why? Because the bonds are going to be more secure, more fixed income type of investments and they're going to lower the volatility, lower the risk. By 2035 you should be halfway to 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. So it's easy to do obviously and it's nice because then they're going to use the common kind of concepts and conventions to do the automatic allocation which for the most part should be pretty good place to go. So life cycle fund investors can easily put their investing activities on autopilot with just one fund which is again great. You can start to invest in one fund and get the benefits of the diversification without having to kind of agonize too much over all the different, you know, different mixes that you're going to do automatically. Now you could use this as like one fund that you try to have your underlying fund and you might use a strategy of having smaller funds if you want to play with it a little bit meaning if you want to put a little bit more weight in a particular segment of the market or a little bit more weight in bonds or stocks then you could buy another fund to kind of complement your major investment which would be something like a targeted fund. That's one strategy that you might consider. The fixed asset allocations of life cycle funds promise to give investors the right balance portfolio for them each year for investors who seek to take a very passive approach to retirement. A life cycle fund may be appropriate. So if you're not going to be actively involved all the time with your investments then a life cycle fund is designed to try to do that kind of whole balancing act automatically. So that would be a good decision there generally. Most life cycle funds also have the advantage of a present glide path. A preset path offers investors greater transparency which gives them more confidence in the fund. A life cycle funds glide path provides for steady decreasing risk over time by shifting asset allocations towards low risk investments. Investors can also expect a life cycle fund to be managed through the target retirement date. Criticisms of life cycle funds so everything has its pros and cons of course so 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 Schiller 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. So obviously when you're when you have a longer time horizon the idea would be if you're saving for retirement then you've got a lot more time to put that money away. But clearly when you're at a younger point in your life cycle you might not be able to save as it depends on your circumstances in terms of how much you could save. It's also the time in people's life cycles when they're limited on cash possibly taken out alone for the home and so on and so forth. So so you have that little wrinkle in the theory. So as a result younger workers are exceptionally vulnerable to unemployment during recession. So and this is just always going to be an issue when you're thinking about retirement especially if you have like debt. The question is and we've talked about this in prior presentations at what point should you start your investing. You know if you're paying down like student loans or if you're paying down say the mortgage then that's going to be difficult to make the decision of when should I be paying down the debt and when can I start investing and then there's questions of well I'd like to be able to invest in such a way that I can get tax advantages of the investment possibly putting the investment under the umbrella of an IRA or a 401k plan but I need the cash to be able to do that number one and number two I might need the money in the future before retirement right. If there's an emergency or something like that then on the younger age you're usually tighter on the cash and you need the money. So there's always a cash flow concern that will be dependent on an individual's particular situation. So a young investor who takes on high levels of risk might be forced to sell stocks at the worst possible time. So clearly if you if you put your investments in a very aggressive kind of stance and there's cash flow problems in part due to the aggressive stance then you're when when the market is at its worst time to be basically pulling the money out which is going to be the floor typically that's when you typically want to buy if you have a cash flow problem that's when you're going to have to pull out of of the market by necessity needs and that would be bad as well. Investors might also prefer a more active approach. So clearly this is a passive approach for those that want to take a more passive approach and you could modify it to make it more active by using it as your core investment strategy and then possibly investing in other index funds or something like that or whatever funds you want in order to weight the weights a little bit differently for example in your overall portfolio. So those investors should seek a financial advice advisor or use other types of funds to meet their investment goals. Here's another world example of a life cycle fund. You got the Vanguard target retirement 2065 trust or 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 translation their allocations for risk management. The Vanguard target retirement 2065 asset allocation remains fixed for the first 20 years with approximately 90% inequities and 10% and bonds. So that's going to be a little bit more on the risk side because you got more money on the equity side of things that on the bond side of things for the next 25 years leading to target date the allocation gradually moves towards the bonds at the target date the allocation is approximately 50 and equities 40% bonds and 10% in short term tips the allocation to bonds and short term tips gradually continues to increase in the 7 years following the target date after that date the allocation is fixed at approximately 30% stocks 50% bonds and 20% short term tips so once you hit the target date if you're in retirement you might be in a situation at that point where you're living off of the proceeds right which means you would might want your money more allocated towards the fixed income which might be the bonds and might be certain types of stocks that are going to have more equity I mean I'm sorry stocks that have more dividend that they're going to have distributions on so that those distributions might be something that you can live on so you can keep the investments rolling and hopefully be pulling out the dividends and interest and to do that you need investments in the types of assets like bonds that give interest and stocks that pay dividends which are usually the more secure big cap stocks