MORE THAN 20 years ago, the launch of the 401(k) put workers of all stripes in charge of investing for their own retirement, often with the help of a little employer-sponsored education and online financial calculators.
The strategy was that companies "needed to educate their employees and eventually they will learn to do things the right way," said Joseph C. Nagengast, senior consultant with Allied Consulting Group, which advises employers on 401(k)s. "That effort, most of us concede now, has failed."
While workers may be great at their jobs, many don't have the time or inclination to become investment gurus. Instead, they may overreact to short-term blips in the market. More often they underreact, making investment decisions when first hired and not making adjustments thereafter. Such reticence has fueled some of the criticism of President Bush's proposal to have workers invest part of their dollars going into Social Security.
To counter this, more employers are adding life-cycle funds to 401(k)s. These funds take the guesswork out of investing by choosing a mix of stocks and bonds based on workers' appetite for risk or when they plan to retire.
Workers are expected to choose a single life-cycle fund, which in turn typically invests in five or as many as 20 stock and bond funds. Additionally, the life-cycle fund automatically adjusts its portfolio, so workers don't have to lift a finger as market conditions change.
"Life-cycle funds help us overcome our own worst instincts," Nagengast said.
Fifty-five percent of large employers in 2003 offered life-cycle funds in their 401(k)s, up from 35 percent two years earlier, according to Hewitt Associates. The benefits consulting firm plans to release an updated study this month, which is expected to show that life-cycle funds have gained a bigger foothold in retirement plans.
Life-cycle funds also are one of the fastest growing products in the fund industry. At the end of last year, there were more than 244 such funds with $139 billion in assets, up from 205 funds with $101 billion the year before, reports Lipper Inc., which tracks funds.
Still, financial experts warn all life-cycle funds aren't the same, and investors need to choose the right one for them. Another problem is that many investors use life-cycle funds incorrectly, defeating the funds' purpose.
Life-cycle funds aren't brand new, but the product and the terminology is still evolving. Basically, there are two types, as defined by Lipper.
Lifestyle funds have a fixed asset allocation, say, 80 percent stock funds and 20 percent bond funds. Investors choose a fund that matches their tolerance for risk: conservative, moderate and aggressive.
Lifestyle funds regularly adjust their portfolios so they keep the same allocation year after year. It's up to the investor to switch money out of the fund if, say, they want a more conservative allocation as retirement nears.
The other type of life-cycle fund is a target retirement fund. Here, investors simply choose a fund based on when they'll need the money, usually their retirement date. So, a 40-year-old today planning to retire at 55 would select a 2020 fund.
The holdings in these will gradually become more conservative as the target date approaches, without investors having to do anything.
Employers, long hesitant to give financial advice to workers, tend to like target-date funds because it's easier for employees to know when they'll retire than to define their own risk tolerance, said Ned Notzon, chairman of T. Rowe Price Associates' asset allocation committee.
Not all target-date funds are alike, though. Asset allocations can differ widely between funds with the same target date, but from separate companies.
Price's Retirement 2025 Fund, for instance, holds 84 percent of its assets in stocks and nearly 15 percent in bonds. The Vanguard Target Retirement 2025 Fund holds about 59 percent of assets in equities and nearly 41 percent in bonds.
Workers need to look at the allocation to decide whether it is too aggressive or conservative for them.
As always with funds, investors want to be aware of fees that erode returns. Investors will pay a fee based upon the management fees of the funds within the life-cycle fund.
Some fund companies also charge a fee on top of that. Price and Vanguard don't do this, and last month Fidelity Investments dropped its add-on fee.
While life-cycle funds attempt to make investing easier, people often use them incorrectly. The funds are designed to handle all or the bulk of investors' assets, but many workers treat them like any other fund.
Hewitt found that 401(k) participants who invest in a life-cycle fund typically put one-third of their assets in that fund and spread the rest of their money in company stock and other funds. Reports of people who lost their life savings by investing it all in one area - such as technology stocks or Enron Corp. - is one piece of investment information that has resonated loudly with workers, who likely figure the more funds the better.
"That defeats the purpose" of life-cycle funds, said Notzon, adding that fund companies go through a lot of trouble to get the right mix of growth and value; small-, mid- and large-cap stocks; and domestic and international equities; and investment-grade and high-yield bonds.
"People are uncomfortable with just investing in one fund," said Lori Lucas, director of participation research at Hewitt. "People hear this message, 'Don't put all your eggs in one basket.' With [life-cycle] funds, it's appropriate to put all your eggs in one basket."
One good thing is that those investing in life-cycle funds, even incorrectly, tend to own less company stock than the typical 401(k) participant, making them more diversified than average, Hewitt found.
Life-cycle funds do have drawbacks. Financial companies often use only their owns funds when building a life-cycle fund. The problem is the company may have an excellent large-cap stock fund, but a mediocre bond fund.
"A target retirement fund is a long-term relationship with that money manager," said Lucas Garland, a research analyst with Lipper. "You want to be comfortable with the underlying lineup of funds and the reputation of that firm."
Some large employers, though, are creating their own life-cycle funds using the funds available in the 401(k) plan, Hewitt's Lucas said. That way the life-cycle fund isn't concentrated with one fund company, she said.
To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose @baltsun.com.