Mutual funds with a mind of their own


Published: Sunday, January 30, 2005 at 6:01 a.m.
Last Modified: Saturday, January 29, 2005 at 11:15 p.m.
Set it and forget it.
It sounds like the slogan on a ubiquitous late-night TV infomercial, but it's also the main selling point of a relatively new breed of mutual fund that promises to put your investment plan on automatic pilot.
These funds - variously called "life-cycle," ''target-date'' or ''target-maturity'' products - are aimed at correcting a common investment mistake: the failure to adjust your portfolio as you age.
Young people starting out in their careers, for example, are generally advised to put more money in stocks in hopes of exceptional returns over the long run. But as they near retirement, workers are urged to shift more of their portfolios into bonds and cash to lessen the risk of losing their nest eggs during market downturns.
The trick is in striking the right balance of investments - stocks, bonds, cash and international securities - and remembering to tweak the formula as the years roll by. The beauty of life-cycle funds, fans say, is that experienced fund managers do this for you.
''Target-date funds are an easy and efficient way to get a diversified portfolio with a minimal amount of effort,'' said Geordie Crossan, president of NBS Financial Services Inc. in Westlake Village, Calif.
That message has not been lost on investors, who are flocking to the funds. Assets held in life-cycle funds have more than doubled in the last three years to $72.5 billion, according to Morningstar Inc., a Chicago-based mutual fund research firm. Although that's a small fraction of total mutual fund assets, it's an astounding amount for a fund category that didn't exist a decade ago, Morningstar fund analyst Kerry O'Boyle said.
Part of the growth stems from the bear market, financial planners say. Investors whose assets were concentrated in stocks did well during the 1990s but got slammed in 2000-2002. Fed up with losses, many of these investors moved their money into bonds - and missed the big market run-up in 2003.
Those with diversified portfolios, on the other hand, suffered less substantial losses in the bad years and enjoyed modest gains in the good years.
''The average investor has figured out that it's not as easy to invest as they thought it was,'' said Adam Bold, chief executive of the Mutual Fund Store in Overland Park, Kan. "And they're realizing that using asset allocation instead of being all the way on or all the way off the market might be a better solution."
Moreover, planners say, these funds nicely address one of the most common investor errors - neglect. Studies of 401(k) investors have found that about two-thirds of participants pick a fund or mixture of funds when they sign up and then never change those selections, Bold said.
In other words, the 20-year-old who puts all his assets in a domestic stock fund eventually becomes a 65-year-old with an all-stock retirement portfolio. A bear market could then wipe out tens of thousands of dollars in savings, with no time for the investor to make up the loss.
If this 20-year-old chose the target-date fund option instead, he would start out with about 80 percent of his assets in stocks. But by the time the fund's maturity date drew near, he would probably have just 20 percent of his assets in stocks and the rest in less volatile securities such as short-term bonds and money market accounts.
What's the downside? Life-cycle and target-maturity funds - which are similar enough that Morningstar puts them in one category - are all essentially funds of funds.
The fund company that sponsors the target-date fund creates a new fund that invests solely in the other funds that the company offers. Vanguard Group's Target Retirement 2025 Fund, for instance, is made up of four other Vanguard funds - the Total Stock Market Index, Total Bond Market Index, European Stock and Pacific Stock Index funds.
The manager of 2025 has a simple objective - determining how much in stocks, bonds, cash and international securities that someone whose retirement is 20 years away would need and selecting the Vanguard funds that most closely suit that goal.
What the target-fund manager won't do is look outside the Vanguard family - even if non-Vanguard funds perform better in certain markets.
''When you buy a life-cycle fund from one fund company, you are getting the best that they have to offer in each asset class, but it may not be the best that's out there,'' Bold said. ''No one mutual fund company has a lock on all the good funds.''
Moreover, some fund companies charge an extra asset allocation fee to be in a life-cycle fund, which comes on top of the asset management fees already being charged by the underlying funds. Those fees are generally not huge - Fidelity Investments, for example, charges about one-tenth of 1 percentage point - but any additional fees incrementally reduce investor returns.
Fund managers have different philosophies about how to allocate assets. The funds offered by Vanguard, for example, are probably more conservatively invested than those offered by T. Rowe Price Group Inc., O'Boyle of Morningstar said.
In any case, many experts maintain that the benefits of life-cycle funds far outweigh the detriments.
''A lot of people do nothing because they're confused by the choices,'' O'Boyle said. ''They are much better off being in a diversified portfolio where somebody is keeping track of the asset allocation.''
Los Angeles Times staff writer Kathy M. Kristof welcomes your comments and suggestions but cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, Calif. 90012, or e-mail kathy.kristof@latimes.com.

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