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Is a lifecycle fund a good choice for retirement investing?

This slideshow displays how the investments options change from more aggressive to more conservative depending on the length of time until retirement.
This slideshow displays how the investments options change from more aggressive to more conservative depending on the length of time until retirement.
Source: TSP.gov

On March 4th, FedSmith published an article analyzing the lifecycle investment choices for federal employees. These particular lifecycle funds are within the federal government's Thrift Savings Plan (TSP) which is only available to federal employees and military personnel. The TSP in similar to a 401(k) plan in the private sector. Similar funds are available for any investor through many mutual fund companies.

For federal employees, the TSP is a good deal. It has the lowest expense rating of any investments available through mutual fund companies. It is even lower than Vanguard, usually considered the fund company with the lowest expenses available.

Jason Zweig, a columnist for the Wall Street Journal observed: “The TSP funds are dirt cheap. The average U.S. stock index fund charges 0.59% in annual expenses, or $59 per $10,000 invested. The TSP funds charge just 0.025%, or $2.50 per $10,000–less than one-20th the cost.” (emphasis supplied)

Federal employees that invest in the TSP have the advantage of investing in funds that have cut expenses to the bone compared to other options available. The C fund, based on the S&P 500 index fund, usually beats or ties the S&P 500 index.

A lifecycle fund provides automatic diversification. It is an investment for those who do not like to take the time or make the effort to balance their investments between various stock and bond funds. For older investors, there is a greater percentage of the fund invested in bonds and less in stocks. For younger investors with a longer time before they retire, there is a much smaller percentage invested in bonds and more in stocks.

For federal employees under the Federal Employees Retirement System (FERS), investing in the TSP should be an easy decision. For new employees:

  • An employee's agency automatically enrolls an employee in the TSP and 3 percent of basic pay is deducted and deposited in the traditional balance of your TSP account.
  • The employee starts receiving automatic agency contributions equal to 1 percent of pay from the agency — beginning with your first pay period.
  • An employee receives agency matching contributions equal to 3 percent of pay from the agency — beginning with the first pay period.

An employee can opt to invest in one of the lifecycle funds or another fund. For many new employees who are not experienced or knowledgeable investors, the lifecycle fund may be the best choice to start investing.

Here are some of the advantages of a lifecycle fund, or a similar fund with a different name.

  • Less risk through broader diversification: Each fund will normally invest in an index fund giving the investor broad diversification among types of investments.
  • A professionally managed asset mix: Fund managers will gradually shift each fund's asset allocation—to fewer stocks and more bonds—making the fund more conservative the closer you get to retirement.
  • Automatic rebalancing: The managers will maintain the current target mix, freeing you from the hassle of ongoing rebalancing.

A company such as Vanguard has these types of funds available to anyone who wishes to invest in them as long as the investor meets some minimal requirements.

For most investors, consulting with a tax adviser is a good idea as it will give the investor a better idea of how to invest and to minimize taxes. A lifecycle fund, for example, can be used in an account where the investment proceeds build up without paying taxes until money is withdrawn. For others, using such an account may be a good investment even if taxes must be paid each year on the profit in the account.