Disadvantages of Using Life-Cycle Funds

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Disadvantages of Using Life-Cycle Funds

There are numerous "cons" associated with life-cycle fund investing that are much less obvious than the "pros."

Expenses

Keep in mind that there are a lot of funds involved in the "fund of funds" approach. Each of those underlying funds has an expense ratio—a measure of what it costs an investment company to operate that mutual fund. Those expenses, of course, reduce your return.

All funds must pay recordkeeping, legal, accounting and auditing fees. But the biggest expense is the fee paid to a fund’s investment manager or adviser. Depending on the type of life-cycle fund, operating expenses vary widely. Generally, actively managed fund expenses are higher than for passively managed funds, and the difference can be material over the course of a career. Whether the actively managed fund advisers "earn their keep" has always been a matter of hot debate among the professional investment community, and it’s something you should consider.

Simplicity—maybe not

You should carefully compare life-cycle funds offered by the various mutual fund companies. Note that there are significant differences, in that the fund with your target retirement date will not have the same asset allocation at each company. In other words, at one company, the life-cycle fund with a target date 12 years away might be 75% composed of stock mutual funds, while another company’s offering might have 60% in stock mutual funds. These differences are important; likewise with respect to the active-versus-passive management approach. Ditto regarding the differences in fund expenses.

All these areas of difference mean that—despite the supposed simplicity of the life-cycle fund concept—you ought not use a "dartboard" approach when choosing a life-cycle fund. You are not off the hook when it comes to doing your homework to find the life-cycle fund that is right for you. The need to consider these factors detracts from the simplicity of the life-cycle fund concept, which is a chief advantage touted about this investment vehicle.

Coordination

Because the asset mix in a life-cycle fund changes over the years, it can be difficult to coordinate a life-cycle fund with other assets for a good overall balance. Therefore, the usefulness of a life-cycle fund diminishes unless the large bulk of your retirement assets are in only a single life-cycle fund. Other investments outside the life-cycle fund change your total asset allocation, and this defeats the purpose and advantage of the life-cycle fund as an investment vehicle.

Limited universe of investments

Every mutual fund company’s life-cycle fund offerings are composed of nothing but that company’s own underlying mutual funds. You are trusting all of your assets to a single company. On the one hand, it’s an easy way of putting all your eggs in the basket of a mutual fund company you like and trust. That’s good. On the other hand, it’s still a single basket, and perhaps that’s not so good.

Additionally, life-cycle funds from a given company are composed of underlying funds from only that mutual fund company, which might not have the strongest performers in all categories.

Duplication

You’ll often find substantial duplication within a target maturity fund. In other words, many of the individual funds that make up a life-cycle fund are likely to contain holdings in a number of the same companies. Therefore, the diversification you might be aiming for is not really there.

The asset allocation might not actually suit your needs

Of course, a lot depends on your starting balance and the performance of the fund, which is never guaranteed. But as your retirement target date approaches, your account balance might be inadequate to meet your retirement needs. In this situation, a fund that moves to a more conservative asset allocation may fall short of providing high-enough investment returns to provide an adequate retirement nest egg.