Mutual Fund Objectives in Asset Allocation

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Mutual Fund Objectives in Asset Allocation

When considering mutual funds in your asset allocation model, it is also important to consider the funds’ objectives as stated in the fund prospectuses. Make sure that both a fund’s objectives and your financial goals are on the same track.

Life-cycle funds address asset allocation

Another common approach to asset allocation through mutual funds is the use of life-cycle funds. A life-cycle fund is a mutual fund whose portfolio is based on the specific time horizons and risk levels of its investors. Many firms offering these funds will first ask an investor to sit down with an investment professional who will assess the client’s risk tolerance, investment preferences, and investment goals. Armed with this information, the mutual fund company will then recommend a life-cycle fund that closely mirrors the investor’s preferences.

Whether part of a life-cycle approach or not, most mutual funds are created and managed with an eye toward some pre-determined risk level. The three general levels of risk are conservative, moderate, and growth (a close relative of which is aggressive growth). Generally speaking, a conservative fund is most concerned with preservation of capital—meaning that it will forgo higher returns in exchange for less volatile performance. Current income, through bonds and preferred and blue chip stocks, is often the primary objective of a conservative fund.

Moderate funds seek to balance

A moderate fund is one that seeks to strike a balance between preservation of capital and higher returns. While not considered a growth fund, the moderate fund will invest more aggressively than a conservative fund, giving up some level of safety in exchange for the possibility of higher returns. This approach is said to be growth-and-income oriented, meaning that the fund will blend fixed investments like bonds with growth investments like common stocks.

What growth funds seek

The growth or aggressive growth fund typically invests almost entirely for capital appreciation. Managers of growth funds, as well as investors in growth funds, understand that the road to long-term growth is paved with short-term risks and possible losses in principal. However, this is an acceptable tradeoff. The typical growth portfolio will consist almost entirely of common stocks.

The measure of success of an asset allocation model is ultimately whether you meet your objectives. Choose mutual funds that are likely to achieve your goals.