A New Generation Of Life Cycle Funds
By: Julie Caron & Michael Marmoreo
Most financial planning experts agree that in order for people to maintain the same standard of living when they retire, their retirement income needs to be equal to at least 70 per cent of their pre-retirement earnings. Government pension plans will provide a modest base income to which additional savings must be added, mainly from employer pension plans and personal retirement savings. With the baby boomers retiring and the life expectancy of Canadians increasing, employer pension plans have become an essential component of the benefits offered to employees.
While people understand the importance of saving for retirement, the average person doesnʼt generally show a great deal of interest in the financial planning associated with this important task. Most people would rather go out with their friends on a Saturday night than sit at home doing something as dull and tedious as planning for their retirement. As a result, group pension plan sponsors need to appeal to their employees and promote the importance of saving for retirement so the plan members will be more inclined to join the pension plan and make regular contributions.
To simplify matters for plan sponsors, there are investment solutions designed specifically to make enrolling in a group pension plan as easy as possible, and to make the process of choosing investments fast, easy, and efficient.
Keep It Simple
The ʼ90s were a decade of ʻà la carteʼ solutions driven by the demand from plan sponsors to give members more investment choices to enable them to build their own investment portfolios. However, the volatility of the stock markets of the past few years has made investors realize that investing isnʼt as easy as they thought.
Since then, people have demonstrated a strong need for simplified investment solutions. Thus, in the past few years, we have witnessed a strong trend towards turnkey investment solutions such as asset allocation funds. These solutions have the advantage of offering a series of diversified investment portfolios, managed by investment specialists, that respect the profile of each investor.
A personʼs investor profile is associated with their risk tolerance level. This is measured by assessing various characteristics of the investor – their personal financial position, age, their investment horizon, their economic and financial knowledge, and their tolerance to risk. Generally, the tool used for this assessment is a questionnaire where the scoring system classifies the respondents into a particular investor profile category, depending on their score. These approaches should satisfy the needs of most plan members.
However, remember, most group pension plan members have little interest in financial planning. Canadian plan sponsors find getting their members to enrol in a plan to be a challenge and wrestle with the problem of too many plan members in a default option, which is only designed as a parking spot while they create an individual portfolio and not as the longterm solution to their retirement planning needs.
So even simpler, but effective, solutions are needed. Life Cycle Funds or Target-Date Funds, which have been available for a few years now in Canada, are a solution which is attracting more attention.
What Are Life Cycle Funds?
Group pension plan members who choose to use a Life Cycle Fund virtually put their portfolio on ʻautomatic pilot.ʼ Life Cycle Funds are diversified portfolios allocated among fixed income and equity funds whose asset allocation, and risk level, is defined by the current age of the plan member and a target retirement year. Designed to make life easier for members, the main characteristic of these funds is that their asset allocation is adjusted automatically to maximize growth potential at the start of the investorʼs career and then gradually, over time, become more conservative thereby preserving their capital as the retirement date approaches. In other words, these funds use an old fundamental investment principle – diversification – and add a dynamic dimension – over time – so plan members can be sure that their investments are in line with their needs at all times.
Since their creation, Life Cycle Funds have gained in popularity thanks to their simplicity and flexibility. These funds offer a solution that is unique in both the peace of mind they offer investors and the focus they preserve.
Life Cycle Funds meet a growing need to invest appropriately for retirement. Investors who do not have access to such solutions must determine how to allocate their assets, rebalance their portfolio periodically, and make adjustments over time to ensure that their investments continue to meet their changing needs. Life Cycle Funds offer a turnkey solution that evolves over time.
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