Still too much cycle in life cycle funds, study finds

Putnam Institute says excessive exposure to stock market gyrations bigger threat to new retirees than inflation or longevity risk
JUN 14, 2011
In theory, life cycle mutual funds should relieve investors of the thorny task of rejiggering their assets as they move through the stages of their lives. The idea? To transfer assets into less risky investments as investors approach retirement. But a new study indicates that many of the funds do a lousy job of setting investors up for a comfortable retirement. A typical life cycle mutual fund allocates a substantial chunk of its portfolio to stocks during an investor's early retirement years, with the equity portion gradually diminishing through retirement. But according to the study, published by asset manager Putnam Investments, some of the funds hold as much as 30% of an investor's funds in equities at the target date for retirement. That'd dead wrong, according to Putnam. According to the fund firm's investment think tank, the Putnam Institute, the optimal equity allocation for retirees is between 5% and 25% — assuming that the primary goal is not to outlive savings. Any bigger bet on equities leaves an investor vulnerable if the market tanks during the early years of the investor's retirement. That, in turn, can put a big dent in savings, Putnam said. Indeed, a sizable market downturn early on could result in smaller withdrawals throughout retirement. Putnam's research found that this so-called “unfavorable sequence of returns” is an even bigger risk to retirees than inflation or longevity risk. According to the firm, once an investor reaches the stage of net withdrawals from a life cycle fund, that should mark the “terminal allocation” phase of the investment portfolio. But rather than termination, many funds continue with a “roll-down, or glide path.” Such a tactic involves the gradual reduction of stocks in the portfolio well past the retirement date. “It makes no sense to continue rolling down equity exposure past anyone's true target date,” the study found. “And funds that do so are overly risky and misleading.”

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