3 shortcuts for low-maintenance investing

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Thanks to no-brainer shortcuts such as target-date funds, index funds and lifestyle funds, people who might not otherwise venture out in the stock market can do so without having to constantly tweak their portfolios or pay advisers to do so.

“There are so many forces out there that lead people to believe that they’ve got to make investing more complicated than what it is, and the beauty of the funds … is that they greatly simplify investing,” says Eric Tyson, author of “Mutual Funds for Dummies.”

“But investors need to recognize that is threatening to people who make their livelihood off the complications in the world. Whether it’s actively managed fund companies or financial advisers who make their living by giving advice or managing money, people are going to hear counterarguments,” he says.

Of course, like any investment, these simple mutual funds have drawbacks and benefits. Consider the following pros and cons before getting your investing feet wet.

Low-maintenance investing
  1. Target-date fund
  2. Lifestyle fund
  3. Index fund

The target-date fund

What it is: Also known as a target-maturity, target-retirement or life-cycle fund, the target-date fund is the one with a number on it — it’s your retirement year, or the year you plan to start extracting money from the fund. As the date nears, the fund’s asset allocation shifts into a more conservative stance.

Pros: You get diversification in a single fund and automatic adjustment of your asset allocation as you approach your target year. “The advantage of the target-date fund is that as you’re getting closer to using the money, then they will be gradually scaling back the risk, which is what you want to do,” says Tyson.

However, some funds get conservative faster than others, so people need to look at not just the current asset allocation but also how it changes over time, says Greg Carlson, a fund analyst at Morningstar. “They need to think about where that fits in with their own risk tolerance and maybe their expectation for returns.”

Cons: Life-cycle funds can charge high fees that are worth avoiding whenever possible. “You’d want to be down around an expense ratio of 1 percent or less, if you could,” says Gail MarksJarvis, author of “Saving for Retirement (Without Living Like a Pauper or Winning the Lottery).”

Not every target-date fund offers quality diversification. People should examine the quality of the underlying funds and how they’ve performed. Target-date funds are usually funds of funds, meaning they hold other mutual funds in their portfolios, often from the same firm. The tenure of the managers on those underlying funds matters, too. “You’re going to be holding the target-date fund for a long time. You don’t want a target-date fund where the underlying funds are changing managers all the time,” says Carlson.

These funds might also skimp on international stocks. “I think the typical target-date fund has something like 20 percent overseas, and that’s on the light side,” says Carlson. “I would shoot for 30 percent or even more, maybe, because there are a growing number of really good businesses outside the United States. You’re really limiting your opportunities if you don’t have much exposure to foreign stocks.”

Lifestyle fund

What it is: Also called asset allocation funds, these are mutual funds with an asset allocation mix that fits a risk-and-return profile chosen by the investor. Asset allocations are based on whether the fund has a conservative, moderate, balanced or aggressive investing approach.

Pros: These funds usually offer broad diversification in one fund, much like a target-date fund. People can supplement with another fund if they want more exposure to small-cap equities or foreign stocks.

Cons: Investors must make their own asset allocation adjustments. Unlike target-date funds, consumers cannot count on the fund to grow gradually more conservative over time.

Luckily, people don’t have to make changes frequently. “It’s maybe a dialing down of 70 percent of equities you had 10 or 15 years ago, and then as you approach retirement you might scale that back to 50 percent, and as you go through retirement, you might continue to scale that back,” says John Nofsinger, a finance professor at Washington State University. He advises always keeping a significant portion in equities because of inflation and longer life expectancy.

Index fund

What it is: A type of mutual fund that follows a particular market index, such as the Standard & Poor’s 500 index.

Pros: Index funds are typically well-diversified and cheap, because investors are not paying for the stock-picking prowess of a fund manager. “If you keep your costs down, you’re going to beat the majority of actively managed funds. That’s the virtue in it,” says Tyson.

Cons: Without active management to move money into the sectors that may outperform others, investors may be disappointed that index funds passively follow the market, both up and down. “An index fund isn’t likely to just blow away its actively managed rivals in a particular year,” says Greg Carlson, a fund analyst at Morningstar. “On the flip side, it’s not going to lag behind the typical actively managed fund, either.”

Another con is that index funds don’t offer one-stop shopping like target-date funds and lifestyle funds. “I don’t think an S&P 500 is a stand-alone holding,” says Carlson. “I think you want exposure to other types of stocks, small-cap and foreign.”

Not all index funds are inherently diversified. “I would just say if you’re going to index, make sure you choose a broad enough index and certainly don’t do things like buy an index fund for a specific industry group — that kind of defeats the purpose,” says Tyson.

Tips for getting started

If you’re considering a target-date or lifestyle fund, make sure the investment approach of the firm managing your fund matches your risk tolerance and expectations for returns. Funds with similar names can have asset allocation mixes that significantly vary from one company to another.

Also consider how fees will eat into your returns. “In the long run, once you make the asset allocation decision, the fees can be a significant determinant of your long-term returns,” says Tyson. He recommends looking at Vanguard as a benchmark for fees.