Although lifecycle funds have grown tremendously in popularity and are being sold to investors as a sure retirement income solution, they and other formulaic asset allocation funds—such as balanced funds, managed accounts or funds that use Monte Carlo simulation—may not live up to their promise, according to a report from the
The investment strategy research organization studied the results of such funds over the past 10 years and found that they will likely fail investors because they don’t capture enough of a market’s upside or limit its downside.
Asset allocation funds that react to developments in the market, rather than stick to forecasts, on the other hand, delivered an average annual return of 14.1% over the past 10 years. The worst-performing formulaic funds delivered average annual returns of 6.9%, and when an investor began investing in such a fund in a down market, they delivered average annual returns of 4% over a decade in the best-performing funds and 2.9% in the worst-performing funds.
“Employees investing in their company’s 401(k) plans have been led to believe that they will be set for retirement and protected from undue risk by opting into funds that are keyed to their age, expected retirement date and appetite for risk,” said Compass Senior Vice President Elliot N. Fineman. “Our research shows, in fact, just the opposite will happen. Formulaic funds by their very nature limit the upside in up markets and maximize losses in down markets. The result will be impoverished retirees, the highest of all risks.
“The problem with a [formulaic] investment strategy is that it is never able to overcome the effects of a single down market that will inevitably occur during the life of a retirement plan,” Fineman added. Formulaic strategies are on “cruise control” and disregard changes in market conditions, he said.
