Retirement Fund Choices — Is a Life Cycle Fund For You?
The best retirement fund solution for you may not be the simple one.
Life cycle funds are the closest thing the industry has to a maintenance-free retirement fund. Their popularity in SA is on the increase due to their convenience and perceived simplicity.
Life cycle funds are also sometimes referred to as “target-date funds” and “age-based funds”. Their distinguishing feature is that the overall asset allocation of the fund automatically adjusts as the expected retirement date approaches. Investors’ overall asset allocation would tend to be moved from aggressive assets like equities and property while they are young and into more conservative assets like bonds and cash as their retirement date approaches.
When comparing life cycle funds, it is important to note that having the same target retirement date does not necessarily mean that the different funds have the same investment strategies or asset allocation (the allocation of investment funds between bonds, property, cash and equities).
The companies managing these funds do not always agree on the appropriate asset allocation. If there are two funds with the same target retirement date, and one has a higher allocation to equities than the other, this means that the first fund has a higher risk profile (and potentially offers better returns). The degree of risk to which portfolios are exposed is extremely important and should not be taken lightly. The funds also have different approaches to investing. Some life cycle funds may be actively managed while others may be passively managed.
A Life cycle retirement fund does have some benefits – it protects the volatility of investors’ pension capital as they age.
However, there could be disadvantageous returns as a result of market-timing risk – where exposure to investments is changed before the investments have had a chance to provide an appropriate return. This could happen if, for example, an investor reduced exposure to shares from 75% to 50% at a time when the share market had just dropped 25%.
A customised strategy would ensure market exposure with reference to client retirement fund requirements or goals, and appetite for uncertainty while taking account of market conditions. As the exposure to markets in a life cycle fund is changed based on age without any other references (in most cases) this could result in disadvantageous returns.
Although life cycle funds are seen as a convenient and simple way to invest they are definitely not for everyone. Two people of the same age may have very different retirement goals and objectives. For example, if there were two people of the same age with the same retirement capital, but one wanted to spend R20 000 a month in retirement and the other wanted to spend R30 000 per month, the second person would need to have a more aggressive asset allocation.
A life cycle fund will provide an outcome without reference to an investor’s circumstances, requirements, risk appetite, market conditions and relative opportunities.
Everyone needs a retirement fund in some shape or form. You need to put enough money away for retirement, consistently, from an early age. Choosing the correct investment strategy will not support a retirement if sufficient savings have not been put away. Consult a fee-based independent financial planner to determine the appropriate amount that you should be saving and to ensure that your financial plan is tailored for your specific circumstances.
Ian Beere, CA(SA) CFP, is a partner at Netto Financial Services and was the financial planner of the year last year.
