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Lifecycle Funds

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NPR featured an article about lifecycle funds.  These are mutual fund that are supposed to automatically adjust to your age and time before retirement by balancing your stocks, bonds and other assets.   Conventional wisdom tells us that your portfolio should be “aggressive” when you are younger, so that you can take advantage of the long term growth potential of stocks.   But as you get closer to retirement, you want to get more conservative, since you won’t have a chance to make up a downturn of the kind we recently experienced.    

Stocks will yield better returns in the long run, but in the long run we are all dead, as the famous economist John Maynard Keynes once quipped. Markets are always rational in the long run, but they can remain irrational longer than you can remain solvent.

The lifecycle fund is simple. You just decide which year you expect to retire and then let the fund do the rest.   The theory is good, but the practice has a couple of flaws. For one thing, a lifecycle fund usually has higher management fees because it is actively managed. People don’t work for nothing and if you give the management to somebody else, you pay for it.  If the market is doing really well, you might not care. The big stock gains may not be the rule of the future, so fees will be a bigger part of your thinking. But the biggest flaw of the lifecycle fund is the psychological trap. 

People buy into these funds and then outsource their brains and judgment to somebody else.  When I talk to colleagues who have put their portfolio into lifestyle funds, they seem to have more certainty than I think is warranted. There is the idea that when they retire, they will have the projected amount of money waiting for them.

Prospectuses always warn that future returns might not resemble the past.   We cannot know the future and we can only predict it imperfectly by trying to project patterns from the past into the future. Lifecycle funds do this too.  Most of us like certainty, especially when thinking about retirement.   The problem is that we cannot have it.  At best we can get ranges of results with different probabilities connected to them.

The good thing about the lifecycle funds is that they might keep you in the market during hard times and keep you from doing silly things during boom times. Many investors do exactly the opposite of what they should. They buy risky investments and stocks when these things are going up and the prices are high. When prices decline, they sell.  That means that they buy high and sell low. If you have confidence that the fund is taking care of the risk for you, you may be less tempted to do this.

I do my own lifecycle investments, sort of.  I don’t think you can really time the market.  I meet lots of people who claim that they can, but they don’t seem to have the piles of money earned by smart investing that you would expect if they really could.  

I just rely mostly on index funds.  I used to think I could pick stocks well, but I was mistaken.

It is not a smart idea to have all your money in financial investments (i.e. stocks, bonds). Real estate is a good thing too, and with the recent decline in prices it might even be a good time to buy.  Of course, I have my own unusual investment in forestry.   You could call forestry a subset of real estate, but since it has the agricultural production aspect, it is significantly different.


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