Is the strategic asset allocation of your pension losing you money?

Lifestyle pension funds, sometimes called Lifecycle or Target Date Funds, are totally in vogue. They appear to be the weapon of choice for pension providers and advisers alike. I did a quick Google search for “lifestyle pension funds” and found 2,910,000 matching results. In the US, Vanguard estimate that more than half of all defined contribution pensions are now lifestyle funds.

But there’s an inherent flaw in the way strategic asset allocation is determined for these funds. And it could be destroying your wealth.


How Lifestyle Funds Work

At its core, and stripping away all its complexities, retirement planning is really about finding the best way to achieve your retirement goals.

Common wisdom holds the principle that the allocation of your portfolio between different asset classes should shift over time.

It says that the single best approach is for you to start out with a high proportion (up to 80%) of your pension fund invested in equities when you are young, and then gradually move your capital into bonds during the later years of your career. Some propose that you should have reduced your equities exposure to 40% by the time you retire; others argue it should be an even 50/50 split between equities and bonds.

lifecycle asset allocation graph

A lifecycle asset allocation strategy reduces equities exposure over time

Lifestyle funds automate this type of asset allocation strategy (called a lifecycle strategy) and use one of a number of similar calculations to drive the desired change in portfolio mix over time. Their aim is to ensure that you benefit from the growth potential of higher risk investments in the early years and then protect your accumulated wealth as you get older.

Automating the process simply reduces the cost of managing your fund. They are simply a pre-packaged version of the de-risking process you might otherwise implement for yourself or with the help of an independent financial adviser (IFA).

The Problem with This Type of Strategic Asset Allocation

The problem with the lifecycle strategy is that your fund is invested in lower performing asset classes just when it has the greatest growth potential, late in your career. That’s the time when you stand to gain the most from the compound growth of a larger portfolio balance. It’s a principle called the Portfolio Size Effect.

Unfortunately, growth and risk go hand-in-hand and you can’t have one without the other

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And yet, it’s at precisely this time that a lifestyle fund would be moving your money into a low risk asset class that (historically) delivers relatively low growth rates. You see, unfortunately, growth and risk go hand-in-hand and you can’t have one without the other. So if you want lower risk you need to accept that your fund growth will probably also be lower.

quote about problem with lifecycle funds

By moving your invested funds to a lower risk asset class, the “automated rules” are limiting the possible growth of your pension, in favour of a preferred, lower risk outcome.

But does a lower risk, lifecycle strategy really provide greater economic benefit than a more aggressive strategy, where your money is kept in riskier assets right up until retirement? If not, using a lifestyle fund would be counterproductive to your retirement goals. It would be akin to shooting yourself in the foot.

The Counter Intuitive Approach

Observing the almost meteoric rise of lifestyle funds after the introduction of auto-enrolment legislation to the US in 2006, researchers Basu and Drew set about answering whether a lifecycle strategy really does provide a better outcome for a typical investor.

Their concern was that the portfolio size effect might outweigh any risk benefits provided by a lifecycle strategy. The conclusions of their research were shocking.

In their study, Basu and Drew developed a contrarian strategy that was used to challenge conventional wisdom in the pensions industry.

graph of strategic asset allocation for contrarian strategy

Basil and Drew contrarian strategy increased equities exposure over time

Their alternative strategy flipped the asset allocation rule set on which the lifecycle strategy is based on its head and increased (rather than decreased) risk exposure over time. Wholly counter-intuitive, it held only cash and bonds for younger investors, and gradually shifted to 100% equities as retirement approached.

The two strategies were tested head-to-head by simulating the investment returns likely to be achieved over a 41-year career using historical investment returns for equities, bonds and cash in the US from 1900-2004. It involved roughly 10,000 simulations in total.

The research revealed that the mean and median fund values at retirement for the contrarian strategy were 42.3 and 29.7 percent larger than those of the lifestyle fund. A significant improvement which they found held true for all but the most conservative of investors.

The Increased Returns of a Contrarian Strategy Have Stood Up to Scrutiny

Clearly this was big news and the research was not without challenge.

Professor W Pfau of the National Graduate Institute for Policy Studies in Tokyo identified a number of weaknesses in the original research and he published further research of his own in 2011. In his study, Pfau sought to overcome these weaknesses and concluded that:

The contrarian strategy provides a higher probability for reaching a saver’s investment goal (except where a person’s retirement savings goal is relatively modest or the person has already saved much more than the 9 percent of their salary).

The differences in performance between the contrarian and lifecycle strategies were not as great as those proposed in the original research, but mean and median improvements for the contrarian strategy were still 12.7 and 8.1 percent respectively.

Only on 36% of occasions did Pfau’s more realistic lifecycle strategy beat the contrarian strategy.

lifestage investment performance statistic

Downside Risk is the Fly in the Ointment

Faced with such convincing evidence of the upside benefit of adopting the contrarian strategy, you might wonder why lifestyle funds still exist?

The answer is (as always) in the downside.If markets were to fall immediately before your retirement, a lifestyle fund should offer greater protection for your accumulated wealth. You’d be insulated from the excesses of the equities markets by the cash and bonds you’d be holding. And that’s exactly the reason why lifestyle funds exist.

However, the question then arises as to how much is that “insurance” worth? Is the potential upside you’d be forfeiting worth more or less than the value you’d get from the insurance policy?

The answer to that question depends on your attitude to risk.

If you are a particularly cautious investor, Professor Pfau would argue absolutely not. The potential gains of adopting the contrarian strategy would not be worth the cost to you if it went wrong.

In contrast, he concluded that investors with a greater than average appetite for risk could realise substantial benefit by moving away from a lifecycle strategy.

Investors with a greater than average appetite for risk could realise substantial benefit by moving away from a lifecycle strategy

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So the higher your appetite for risk, the more you stand to gain from avoiding lifestyle funds, even after taking into account any downside risk.

[Note: You can use our free Attitude to Risk Assessment to calculate your risk score and find out what portfolio mix might be a good fit for you.]


Lifestyle pension funds are the default choice for many investors. However these funds may limit the future growth of your investment portfolio as more of your money is shifted into bonds and cash over time. Lifestyle funds make this shift in order to help protect your portfolio from losses as you near retirement.

However, if your Attitude to Risk score is higher than normal, you should consider building your exposure to equities over time rather than reducing it. Research shows that you will have a better chance of reaching your investment goals by adopting this counter-intuitive investment strategy.

So is moving away from the traditional lifestyle fund right for you? Making sure you have the asset allocation strategy is something which we cover in our Pensions Options service. If you’d like to talk about this concept in more detail, feel free to get in touch.

What do you think about this idea? Good, bad, indifferent? I’d love to hear your views in the comments section below.

Basu, Anup K. & Drew, Michael (2009) Portfolio size effect in retirement accounts : what does it imply for lifecycle asset allocation funds? The Journal of Portfolio Management, 35(3), pp. 61-72.
The Portfolio Size Effect and Lifecycle Asset Allocation Funds: A Different Perspective The Journal of Portfolio Management, 37(3), pp. 44-53.
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About the Author

By Nigel Reeves: My mission is to provide the quality, honest & jargon-free pension advice that people need to secure the retirement they deserve. At home, I'm a family man and an active supporter of grassroots sports!

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