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Study Supports Use of 'Lifestyle' Type Funds

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Study Supports Use of 'Lifestyle' Type Funds

Reveals common 401(k) investing misbehaviors

By Stephen Miller, October 2007

A large majority of 401(k) participants (84.2 percent) who select investments other than "lifestyle" funds would have fared better in a lifestyle fund portfolio than they fared by selecting their own investments, according to a study commissioned by financial services firm John Hancock.

In the 10-year analysis (1997-2006), participants who had chosen to allocate all of their contributions to a single lifestyle fund earned, on average, 7.2 percent vs. 5.3 percent for the non-lifestyle participants.

Lifestyle funds, as defined by John Hancock, are professionally managed "funds of funds" — that is, a single fund that invests in a number of underlying funds to achieve a diversified portfolio that seeks to maintain a stated, typically moderate risk level. They can include target-date or "lifecycle" funds that, as the participant ages, shift the asset mix from predominantly high growth-oriented investments with greater short-term risk to capital, such as growth stocks, to those with less growth potential but lower short-term risk, such as bonds.

The study, run annually by Burgess + Associates for John Hancock, has shown consistently that the non-lifestyle participants as a group fare worse than lifestyle-fund participants.

Non-lifestyle participants as a group consistently
fare worse than lifestyle-fund participants.


But Not for Everyone

A minority of 401(k) investors may take the time to learn about adequate asset diversification and rebalance their holdings over time to maintain a risk level they find acceptable—and might insist on the right to do so as a matter of personal empowerment linked to their satisfaction with the retirement plan. In particular, if their plan offers low-fee index funds that track a range of asset classes, they may be able to create a diversified portfolio that meets their risk expectations at a lower cost than opting for a lifestyle fund.

However, the John Hancock study suggests that a majority of 401(k) participants appear unwilling or unable to accomplish this goal on their own.

Investors Misbehaving

Several investing behaviors of non-lifestyle participants were identified by the study that might explain the difference in returns. Non-lifestyle investing participants, typically, were:

    • Insufficiently diversified. The average number of funds selected by non-Lifestyle participants was 3.9.

    • Not reallocating and rebalancing. An analysis of fund selections by the non-lifestyle participants indicated they tended to allocate a large share of their balances to popular funds at the time of their enrollment and made few changes afterwards.

    • Adopting risk strategies at extremes of spectrum. The non-lifestyle participants were more likely to adopt investment strategies at the extremes of the risk spectrum (conservative or aggressive) than were lifestyle participants.

Funds Vary Widely

All lifestyle (or target-date lifecycle) funds are not the same, and plan sponsors should remember to practice due diligence when selecting from among fund providers, checking into the funds asset diversification strategies and fee structures (to learn more, see the related articles under "Evaluating Funds," listed below).

Stephen Miller is manager of SHRM Online's Compensation & Benefits Focus Area .

Related Articles: Evaluating Funds

Hitting the Target with Target-Date Funds , SHRM Online Compensation & Benefits Focus Area, August 2007 (includes video clip)

All Lifecycle Funds Are Not Created Equal: How to Choose Wisely , SHRM Online Compensation & Benefits Focus Area, February 2007

New Study Rates Lifecycle Funds , SHRM Online Compensation & Benefits Focus Area, October 2006

Other Related Articles:

DOL Final 401(k) Default Rule Excludes Stable-Value Funds , SHRM Online Comp & Benefits Focus Area, October 2007

Most Mid-Size and Large 401(k) Plans Offer Lifecycle Funds , SHRM Online Comp & Benefits Focus Area, October 2007

Lifestyle Funds Portfolios Produced Better Results for 401(k) Plan Participants , SHRM Online Compensation & Benefits Focus Area, August 2006

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