Wednesday, May 16, 2007

Investing Made Simple

There's a simple way to invest that gives you the diversified portfolio designed for long term growth that financial experts recommend. And the best part of it is that you don't have to a lot of research into stocks, mutual funds or other investments. We're talking about lifecycle funds, which are also called target date funds.

Lifecycle and target date funds solve two basic problems investors face. First, you should diversify your investments, so that you don't have all your eggs in one basket. Typically, a variety of stocks and bonds is recommended.

Second, you should change the focus of your diversification as you grow older. In your 20's and 30's, your portfolio should be heavily weighted toward stocks, since they have greater potential for long term growth. Of course, stocks can nosedive in value if the market stumbles--and you can be sure it will stumble every now and then. But when you're young, you still have plenty of time to ride through market turbulence and profit from the next upswing. As you grow older, you have less time to recover from investment losses. Therefore, you should shift more of your portfolio into bonds and even money market funds in order to lock in the gains you've achieved and stabilize your financial foundation.

Given the vast array of investments available, how could an ordinary investor figure out how to diversify, and then how to change the diversification appropriately over time? If you have time every week to devote to investment research and strategizing, you could probably do reasonably well. But what if you have a job to keep, kids to raise, housekeeping to do, and fun to have?

The solution is to invest in lifecycle and target date funds. These mutual funds provide a diversified portfolio for you. All you do is pay in your money and they automatically invest it in a diversified way. They have "target dates," which are years (usually in increments of 5, like 2010, 2015, 2020, 2025, 2030, etc.). You pick a year that's close to the time when you plan to retire. For example, if you were born in 1975 and expect to retire around age 65, you'd invest in a fund with a target date of 2040. Right now, this fund would probably be mostly invested in stocks (probably somewhere around 80% in stocks, with the remaining 20% in bonds). As you grow older, the management firm operating the lifecycle or target date fund will gradually reduce the stock portion of the fund's assets and increase the bond portion. By the time you reach 65, the fund might have something like 30% to 40% of its assets in stocks, and the rest in bonds and money market funds. This conservative allocation is meant to lock in much of your investment gains so that you'll have some certainty for your retirement finances.

As with any mutual fund, you should look closely at the fees and expenses of lifecycle and target date funds. Some are noticeably more expensive than others, and in the long run, high fees and expenses can be costly. Vanguard and Fidelity offer lifecycle or target date funds that have pretty low costs. Other mutual fund management companies may also offer low cost funds.

If you are a bit of a stock market buff, you may want to think about the diversification philosophies of the lifecycle or target date funds you consider. They tend to have slightly different approaches--some are more heavily weighted toward stocks, while others have a greater preference for bonds. Make sure you are comfortable with the fund's diversification philosophy.

With a lifecycle or target date fund, all the investment strategizing and diversification happens automatically. You just pay in your money and the fund's managers do the rest of the work.

More and more 401(k) plans are offering lifecycle or target date funds as an investment option. If your employer doesn't offer them, lobby for them. They'll make the process of retirement saving much simpler for you. You can invest in these funds through an IRA--just open the IRA with the mutual fund management company offering the funds in which you are interested. If you've maxed out your retirement accounts and want to save more, you can always open a taxable account with a mutual fund management company and invest in a lifecycle or target date fund that way.

Doing things the simple and easy way means you're more likely to do them. We all recognize the importance of saving for retirement. Keep lifecycle and target date funds in mind as one of the easiest ways to build wealth.

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