Are Lifecycle Mutual Funds a Good Investment Option?

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In the recent posting series about formulating and implementing an investment strategy that suits your individual situation (see link below for more information), I described in detail the specific, individual index mutual funds that can be used to make up both the equity and fixed income portions of your investment portfolio.
However, in recent years, a different type of combined fund has been developed that is essentially a “fund of funds.” Other names for these types of mutual funds include Target Retirement Funds, Balanced Funds, and Lifestyle Funds.
These mutual funds can be either actively or passively managed, and can contain equity or fixed income investment funds (or a mix of both).
Because of the multifaceted component mix, these Balanced Funds have gathered a big following among investors who want to keep their investing simple by using only one mutual fund.
However, are these funds truly a good option for investors to use? This topic will be the center of discussion in this posting.
According to Larry Swedroe’s book, The Only Guide to a Winning Investment Strategy You’ll Ever Need, the following case can be made for avoiding Balanced, or Lifestyle Funds.
Essentially, the reason that Balanced Funds produce lower returns is that since almost all of these funds are made up of a mix of fixed income and equity investments, one of types of investments is always going to be held in a tax-inefficient location.
Note: Refer to previous post at link below for most tax-efficient locations of different types of mutual funds.
My Money Blog – Tax Efficient Locations for Different Asset Classes
For example, if the Balanced Fund is held in a tax-sheltered account:
-The fixed income mutual funds are being held in a tax-efficient manor. So, this is a good thing.
-However, the equity investments are not being used in the most efficient way due to the following considerations:
• You lose the ability to use losses to minimize your tax liability.
• You lose the ability to use your equity assets for charitable contributions.
• You lose the ability to collect losses at the individual asset class level (in the normal case that one type of asset performs better than others at different times).
• You lose the ability to use foreign tax credits generated from international holdings, which reduce your total tax burden.
Key Takeaway:
So, the key takeaways from this post are shown below –
• Individual investors should take advantage of the ability to hold different types of mutual funds in tax deferred and taxable accounts (see link of location suggested), and should therefore, avoid Balanced Funds containing multiple asset class investment instruments.
• The only time that Balanced Funds should be used is when you know that you absolutely DO NOT have the ability to invest or stick to your investment strategy unless you use this type of instrument.
Keep on learning!

Jacob

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