Lifestyle funds gradually and automatically move your money from riskier assets at the beginning of your investment life cycle to comparatively safer assets as you approach retirement.

They were designed for people who do not want to actively manage their funds and who plan to buy an annuity on a fixed retirement date.

The idea is that as an investor approaches retirement, they should gravitate away from riskier asset classes such as equities, and towards more defensive asset classes such as bonds.

“De-risking as retirement approached was a way to ensure market fluctuation had less of an impact on fund value,” says Claire Trott, head of pensions technical at Talbot and Muir.

However, some experts believe this approach no longer works and that where once lifestyle funds may have been a sensible option for savers, they could in fact harm the financial well-being of retirees today.

An obsolete product?

“Lifestyle funds are an obsolete product – the ideals they were meant to serve no longer apply,” says Martin Tilley, director of technical services at pensions specialist Dentons.

Firstly, April’s pension freedoms and the accompanying introduction of flexi-access drawdown means there is no set date by which retirees are obliged to purchase an annuity.

Second, gilt yields, which determine annuity rates, have fallen significantly. As a result, fixed-income products may no longer be the best option for retirees.

But lifestyle funds do not consider contemporary economic circumstances.

“Interest rates are scheduled to rise, and when they do, the capital value of fixed-interest products will decrease – yet, a lifestyle fund will transition you into them,” Tilley notes.

“No financial adviser would suggest you do that, so why tie into a vehicle that would do so automatically, without taking account of economic realities of the asset classes involved?”

Furthermore, the age at which lifestyle funds switch investments into fixed-income products may have been determined when the saver was in their 20s or 30s, and had unrealistic notions of when they would be able to retire – or would want to. Office for National Statistics data indicates one third of the total UK workforce is aged 50 or over, a 42 per cent rise from 1992.

Despite this, a lifestyle fund would transition an individual into decumulation – the process of converting pension savings into retirement income – at age 50, because that individual believed at 25 they would retire at 55. Their actual retirement may be 10 to 20 years later, and in the current fixed-income milieu, that consumer’s savings would stagnate at best or erode due to inflation at worst.

Alternatives

Ian Goodchild, investment manager at Mattioli Woods, a wealth management firm, believes that beyond not providing a decent return to retirees, lifestyle funds represent “a danger”.

Given today’s environment, he says it is questionable whether moving from equities to fixed interest actually constitutes de-risking.

“The historical perception of fixed interest representing a lower risk option for investors is not accurate in the current market conditions. Retirees will move their hard earned pension pot into an asset class where capital loss is pretty much guaranteed – although the extent will depend upon the duration positioning,” he says.

Goodchild suggests retirees who do wish to move to safer vehicles move their pension pots to cash, or absolute return, rather than fixed interest products. If a retiree intends to enter drawdown, he would advise retaining existing equity exposure.

Relevant when, not whether?

Despite the variety of issues that have been identified with lifestyle funds, Trott recognises they may still be applicable for retirees who intend to buy an annuity, and have a clear idea in advance of when this is likely to be – although she admits the number of people this would suit is diminishing.

“Using a lifestyle fund when you are going to continue to be invested after your retirement date, such as those in drawdown, just would not work,” she says.

“That isn’t to say a revised type of lifestyle fund couldn’t be created to suit this type of investor and retirement strategy, but it would be very difficult to achieve with all the variables available since the pensions freedoms.”

Goodchild believes there remains a need for default investment options among “unsophisticated” investors with no active adviser – and thinks a lifestyle fund “probably” remains the best option.

Tilley concedes that whether a lifestyle fund is still relevant depends on the personality of an investor, but urges everyone in one to review it immediately, and consider whether it’s still appropriate for them.

“Remember – if your lifestyle fund is not reviewed, it will move you to potentially unsuitable investments automatically. Life insurers offer a wide range of unitised funds, and it isn’t costly to move to a more suitable fund, or set of investments. If in doubt, consult a friendly financial adviser,” he says.

Having said that, Tilley advises consumers 10 – 15 years away from retirement to “wait and see” whether fixed-income returns improve. If they do, lifestyle funds may become relevant again.

Goodchild also believes an individual starting their retirement saving today could potentially benefit from a lifestyle fund in future, as the market dynamics at their retirement will “undoubtedly” be different to the current environment.

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