Funds Of Funds: Simplifying 401 Investments

Nation's Business, Nov 1, 1998 by Randy Myers

Want to make life easier for participants in your company's 401(k) plan? Add a fund of funds to their menu of investment choices. Better yet, add several.

Ordinary mutual funds-the most popular 401(k) investment options-typically invest in stocks and bonds. A fund of funds invests in other mutual funds. Also known as life-cycle funds and multifunds, funds of funds allow investors to build a broadly diversified portfolio by making a single investment choice rather than several.

"I define my job as being a surrogate for the investor," says Robert Markman, who presides over the Markman family of multifunds as president of Markman Capital Management in Minneapolis. "I do what you would do yourself if you had my time, resources, and experience."

Because no two investors have the same investment objectives, most funds of funds are designed to synchronize with an investor s age, investment horizon, or tolerance for risk (conservative, moderate, or aggressive). That makes them refreshingly easy to use for workers who don't have the time, inclination, or ability to mix and match from a potentially bewildering array of investment options in their 40 1(k) plans.

Many fund companies offer questionnaires that participants can use to help decide which fund of funds is best suited to their needs.

A Burden Removed

"In every company, you have a few astute individuals who manage their own money and understand stocks and bonds and asset allocation, but the vast majority don't do that and don't necessarily have the tools they need," says Roxanne Fleszar, president of Financial Resources Management Corp., a Peabody, Mass., investment advisory firm that is a consultant to qualified (tax-advantaged) retirement plans. "A lot of them are happy to have the investment burden taken off their shoulders [with a fund of funds]," she says.

Funds of funds are already gaining popularity. Greenwich Associates, a research and consulting firm in Greenwich, Conn., surveyed nearly 500 corporations about the investment options in their 401(k) and profit-sharing plans last year and found that 16 percent of respondents were offering life-cycle funds, up from 10 percent a year earlier.

IBM Corp. is a recent convert. IBM created four Life Strategy funds for its 401(k) plan in 1996. Each invests, in differing proportions, in other mutual funds offered through the plan.

The most conservative Life Strategy fund keeps 80 percent of its assets in bond funds, for example, and just 20 percent in stock funds. The most aggressive fund takes just the opposite approach: It has 20 percent of its assets in bond funds and 80 percent in stock funds. (Stock funds generally offer higher potential returns but greater short-term volatility than bond funds.)

Participants in the company's 401(k) plan are given guidelines for assessing their investment needs and their tolerance for risk, which helps steer them to the appropriate Life Strategy fund.

The asset-allocation mix in the IBM Life Strategy funds stays relatively constant. As investors' risk-reward tolerances change, they can switch money into a different fund.

That's the approach taken by most lifecycle funds that define themselves principally by the degree of risk they take on, including those offered by the Vanguard Group, the nation's second-largest fund company

A View Toward Retirement

Fidelity Investments, the nation s largest fund company, takes a slightly different tack in matching investors with the right life-cycle fund in its stable. Each of its Freedom life-cycle funds is constructed to reflect the approximate year in which an investor will be retiring and the amount of risk appropriate for that investment time frame. (The longer until you retire, the more risk you can afford to take in hope of earning higher returns.)

Fidelity's Freedom 2000 fund, for example, is designed for investors retiring in the next several years. It allocates only about 41 percent of its assets to stock funds, 44 percent to bond funds, and 15 percent to money-market funds. Fidelity's Freedom 2020 fund, by contrast, allocates about 80 percent of its assets to stock funds and 20 percent to bond funds; nothing is put into moneymarket funds.

Unlike the IBM and Vanguard funds, the asset-allocation mix in each of the Freedom funds changes over time; it becomes more conservative as the target retirement date gets closer. The idea is that investors never need to change funds, even as they approach retirement age and become less willing to take risks with their money

Simplifying A Decision

For Jim Rich, the IBM senior investment adviser who oversees his company's $14 billion 401(k) plan, life-cycle funds meet the "kiss" ("keep it simple, stupid") test. They simplify the most critical decision every 401(k) investor must make, which is to determine what percentage of his or her retirement money should be allocated to each of the major classes of financial assets: stocks, bonds, and cash.

Academic studies confirm that more than 90 percent of an investment portfolio's performance is determined by this asset-allocation decision.