Lifestyle funds (sometimes known as risk based funds) have experienced a significant decrease in popularity and use in recent years. For example, very few retirement plan sponsors use these types of investment options in their 401(k) plans as QDIA's. Most plan sponsors use target date funds as QDIA's because, in comparison, lifestyle funds have a major drawback.
Over time, target date fund managers decrease the overall risk of a target date fund as the target date comes closer to the present date. Lifestyle funds don't lower their risk profiles over time. An Aggressive Portfolio will remain an Aggressive Portfolio as long as it exists. As a result, participants who invest in an Aggressive Portfolio eventually end up taking on too much risk as they age.
It takes an affirmative election for participants to decrease their risk exposure and move, for example, from an Aggressive Portfolio to a Moderate Portfolio. Many investors in an Aggressive Portfolio don't realize they are taking on too much risk until a market downturn occurs and they experience a significant loss of their account balance. The worst time to learn that you have taken on too much risk is when you have lost a substantial portion of your investment.
Target date funds use employee inertia (the tendency of employees to set-it and forget-it) in a positive way. Once a target date fund participant invests in a fund, it is not necessary to make adjustments as time goes by. As outlined previously, just the opposite is true with a lifestyle fund. Investors have to identify the various points in their lives when their risk tolerance changes, moving from an Aggressive Portfolio to a Moderate Portfolio and finally to a Conservative Portfolio. Most retirement plan participants have a difficult time judging the points in time when their risk tolerance changes or just get busy with their lives and forget to make adjustments.
Lifestyle funds are also difficult to benchmark. Since each lifestyle fund may be comprised of the investment options in a particular retirement plan, it can be hard to compare it to similar investment options to gauge its performance. For these reasons, many experts believe plan fiduciaries assume a higher level of fiduciary risk when electing to offer lifestyle funds rather than target date funds.
Most observers agree that target date funds are easier and safer to use for both retirement plan participants and plan sponsors.
Contributing Editor Robert C. Lawton is President of Lawton Retirement Plan Consultants, LLC a Registered Investment Advisory firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. Mr. Lawton has over 25 years of experience working with corporations on their retirement plans and is a Chartered Retirement Plan Specialist (CRPS) and Accredited Investment Fiduciary (AIF). He may be contacted at firstname.lastname@example.org or 414.828.4015.
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