What is a Lifecycle Fund?

A Lifecycle Fund is an open-ended mutual fund designed with a pre-determined maturity date and a “glide path” for goal-based investing. You pick a fund that with a “target date” that matches when you will need the money, and the fund’s name will include that year (for example, “Life Cycle Fund 2046”).

Here is how the “driving speed” works for your investments:

• The “Glide Path”: When your goal is far away (like 15 to 30 years), the fund takes more risks to help your money grow faster. During this time, it will invest mostly in equity (65% to 95% in Equity) and a smaller amount in safer options (5% to 25% in Debt). Balance will be in Gold or Silver (0% to 10%).
• Slowing Down: As you get closer to your target year, the fund automatically shifts your money out of risky equity instruments and into safer debt instruments. By the time you are less than a year away from your goal, the fund will only have 5% to 20% in stocks, and 25% to 65% in safer debt.

This leads to automatic rebalancing of your portfolio (similar to NPS).

Key Rules to Know

• Set Timelines: These funds have a minimum duration of 5 years and a maximum duration of 30 years. Importantly, they can only be launched for tenures in multiples of 5 years (e.g., 5, 10, 15, 20, 25, or 30 years).
• Penalty for Leaving Early: To make sure you stay disciplined, these funds shall charge a high “exit load” (penalty fee) if you withdraw your money early. You will be charged a 3% fee if you leave within the first year, 2% within the second year, and 1% within the third year.

The Big Advantage: Built-in Tax Efficiency

Normally, if you manage your own investments, you have to sell your equity to buy safer debt instruments as you get older or reach nearer to a goal. Every time you sell, you might have to pay capital gains taxes.

With a Lifecycle Fund, the fund manager does this shifting (rebalancing) for you inside the fund. This creates built-in tax efficiency for portfolio rebalancing. Because the buying and selling happen inside the mutual fund itself, it doesn’t trigger personal taxes for you until you finally withdraw your money at the very end.

Drawbacks

• Too Rigid: The automatic shifting from risky to safe is locked in. If the stock market crashes right when the fund is scheduled to sell your stocks, it might lock in those losses.
• Not for Emergencies: Because of the high penalty fees in the first three years, it is a bad place to keep money you might need suddenly.
• Debt portion may have a higher duration:  At Bachhat, we do not usually recommend high-duration debt instruments.  However, Lifecycle funds can have debt instruments with residual maturity up to the target scheme maturity.  This can lead to an increase in interest rate risk.

Real-Life Scenarios: When to Use Them and When Not To

Where this WILL work:

• Scenario 1: Kid’s Higher Education Goal: You want to save for your kid’s higher education which is 15 years away.  You can buy a “Life Cycle Fund 2041”. The fund will aggressively grow your money now and automatically make it safe right before they start college, so a market crash doesn’t wipe out their tuition money.
• Scenario 2: Hands-off Retirement: You want to retire in 25 years but know nothing about how to invest in the stock market or how to carry out periodic rebalancing. You just put money into a target-date fund every month and let the fund manager handle the risk adjustments for you.

Where this WILL NOT work:

• Scenario 1: Buying a Car Next Year: You want to buy a car in 2 years. Lifecycle funds have a minimum timeline of 5 years, so they are completely useless for short-term goals. Plus, the early withdrawal penalties would eat your savings.
• Scenario 2: Your risk profile is not aligned to the fund’s risk profile: It assumes a “typical” investor profile where one takes high risk when the goal is far away and zero risk when the goal is near. It cannot adjust to your personal, individual risk tolerance.  .  In such cases, such funds will not work for you.

Important Update: Wait Before You Invest

While Lifecycle Funds sound like a great “fill it, shut it, forget it” option, at present, there is no tax clarity on such funds. Because they automatically mix stocks, bonds, gold, and silver, it is not yet clear whether it can be treated as an equity fund or a debt fund at the time of withdrawal.  We will have to wait for proper tax clarity before these funds can be confidently recommended to investors.

How Will Bachhat’s “Ideal” Lifecycle Fund Look Like?

At Bachhat, we try to hug the market and avoid significant active calls.  Accordingly, our ideal Lifecycle Fund might be one that takes a “passive” approach to equity investing. Instead of a fund manager trying to actively guess which stocks will perform best, the equity portion of this ideal fund would just blindly mimic a major market index (like the Nifty 50). This strategy keeps your fees very low.

For the debt portion, this ideal fund would invest only in “low duration”, AAA-equivalent debt instruments. Focusing on low-duration debt protects your money from sudden drops in value if interest rates go up.

Are Lifecycle Funds an Alternative to NPS for retirement planning?

For many people, these new Lifecycle Funds can serve as a much more flexible alternative to the National Pension System (NPS). NPS also uses a “glide path” (called Auto Choice) that reduces your stock market risk as you get older. However, NPS locks your money in until you turn 60, and forces you to use 40% of your final savings to buy a monthly pension (an annuity). Lifecycle Funds give you similar automatic risk-management but with total freedom at the end. Once your fund hits its target year, you can take all your money out in a lump sum and spend it however you want, without being tied to age 60 or forced pension rules. However, NPS offers certain tax deductions that lifestyle funds currently do not.

Bachhat’s Take

While this is an interesting development, this can never be a default product for all.  We will have to wait for the actual offerings from the fund houses and tax clarity on withdrawals at the time of maturity before such funds can be considered as a part of our portfolio.