Many employers offer lifecycle, or target date, funds as 401(k) options. Lifecycle funds typically make investment allocations, based on a target retirement date (2020, 2030, etc.). These funds invest in different types of investments, such as domestic stocks, international stocks, bonds and money market investments.
The mix is chosen based on the date when you will need to use your money. If that date is a long time from now, the lifecycle fund will be more heavily weighted toward stocks or stock mutual funds. But as the date approaches when you will need your money, the investment mix will become weighted more heavily toward fixed-income or stable value investments, including bonds or bond funds and Treasury securities.
This gradual shift to more conservative investments is designed to reduce your risk as you approach retirement.
How Lifecycle Funds Work
The specific target date is key to determining the way contributions are allocated among the various investments within the lifecycle fund. When the date is many years in the future, a larger percentage is invested in the stocks, which historically have a higher growth potential. This also means there’s greater potential risk to principal. But the idea is that you have time for the market to return to profitability and potentially greater gains in the next market cycle.
As time passes, and you come closer to retiring, the allocation is gradually shifted to put a greater emphasis on the lower-risk bonds or capital preservation. While this allocation won’t produce the level of growth typical of a more stock-heavy portfolio, it will tend to be less volatile. This limits, though doesn’t eliminate, the losses your account may suffer, which is important because your recovery time is shorter too.
Related But Not Identical
Lifecycle funds with the same target date aren’t all alike. The funds that make up a fund of funds can vary substantially from provider to provider. Some lifecycle funds adopt fairly aggressive allocations, with the majority of the assets invested in stocks as the target date approaches. Others have a more conservative mix. You can find the exact combination of investments that make up a lifecycle fund’s portfolio in its prospectus, which your employer should make available to you.
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