Lifecycle funds: Should you invest in target-date funds for your financial goals? Know the benefits, risks and limitations

A new era is underway in mutual funds. Lifecycle funds are being rolled out, ushering in a differenti ated way to invest for time bound goals. Zerodha Fund House has already hit the shelves with two offerings: Zerodha Life Cycle Fund 2036 and Zerodha Life Cycle Fund 2041. Its new fund offer (NFO) for Zerodha Life Cycle Fund 2031 is currently open. NFOs from ICICI Prudential MF for three life cycle funds, maturing in 2031, 2036 and 2041, are open as well. Nippon India MF and Mirae Asset MF too have filed for life cycle funds with varying maturity dates.

For investors, life cycle funds mark a distinct shift in how they invest towards specific goals. But should you map your goals to lifecycle funds of matching tenure? Should these replace existing tradi tional funds in your portfolio that are already building towards your goals?

India’s mutual fund industry isn’t stepping into target-date investing for the first time. Target maturity funds, which were mapped to a fixed maturity year, had a good run a few years ago. But these were pure debt products that tracked bond indices. When income tax rules changed in April 2023 and debt fund gains lost their indexation benefit, becoming taxable at slab rate regardless of hold ing period, the appeal of these funds evaporated almost overnight. New launches dried up soon after. This new crop of lifecycle funds is built differently. They spread across equities, bonds, gold and silver exchange-traded funds (ETFs), and infrastructure investment trusts (InvITs), rather than betting the entire structure on debt taxation staying favourable.


Preparing for a soft landing

Lifecycle funds will automatically de-risk asset allocation as fund maturity date nears.

Pick a goal year, see the fund work

Goal-based investing is not a new concept. Mapping investments to specific goals gives your outlay a defined purpose, helps you stay committed to the journey, and allows you to track your progress. Financial advi sors weave this into clients’ financial plans. Do-it-yourself (DIY) investors have also adopted this habit. But there are some prac tical constraints in how this gets executed.

Traditional mutual funds follow a static allocation approach. They don’t provide for de-risking the portfolio closer to your goal. Leaving the entire corpus exposed to the market close to the finish line can put your goals at risk. Investors have to take on the onus of rebalancing, or have a financial plan ner do it for them. A lifecycle fund works dif ferently. It is essentially a target-date fund, with a pre-determined maturity date. It will automatically adjust asset allocation as the fund’s maturity date nears. The fund will fol low a multi-asset approach, investing across equities, bonds, gold and silver ETFs, and InvITs. The portfolio will shift away from equity to safer instruments over the fund’s tenure, based on a pre-defined glide path.

“The concept behind these funds is that they will start with more equity, and as their maturity—or target date—comes close, the share of equity will be reduced in a phased manner. The idea is that the investor can match the target date in this lifecycle fund with their respective finan cial goal,” observes Ravi Saraogi, Founder, Samasthiti Advisors. The goal could be your retirement, child’s higher studies, a foreign vacation or a bigger car. Pick the fund that suits your target year, and let it run the asset allocation.

All lifecycle funds will follow the same glide path. Essentially, funds with residual maturity exceeding 15 years will be allowed equity exposure between 65-95%. When 10 15 years remain, this will drop to 65-80%, then ease to 50-65% when 5-10 years are left. This further falls to 35-50% and 20-35%, respectively, for residual maturities of 3-5 years and 1-3 years. When less than a year remains, equity allocation will reach 5-20%.

If your goal due date falls beyond the fund maturity year, you get the option of merging into the nearest lifecycle fund, if available. In such a shift, the next fund’s glide path takes over for the remainder of your time horizon. This glide path mechanism enables a safer, more calibrated approach to achieve critical financial goals. It dulls the sequence of-return risk that can wipe out savings if markets crash near your goalpost.

Rohit Shah, CEO, GYR Financial Planners, notes, “The lifecycle fund’s soft-landing mechanism will protect more and more of the accumulated corpus as the goal ap proaches.” Investors don’t have to worry about intermittent volatility during the accumulation phase. This can keep them from succumb ing to their emotions and taking sub-optimal decisions. “Investors remain vulnerable to greed and fear across different time horizons. A lifecycle fund’s auto-pilot alloca tion mechanism is meant to curb their worst instincts,” remarks Amol Joshi, Founder, PlanRupee Investment Services.

But this is not all. Lifecycle funds also make any rebalancing tax-neutral for the in vestor. Normally, when investors shift from one fund to another (say, from an equity fund to a debt fund), they invite a tax event. This tax leakage impedes optimal rebalancing. However, lifecycle funds address this prob lem by rebalancing assets within the fund. The investor only pays tax at the time of fund maturity. This tax deferral allows gains to compound over many years, reflected in a larger corpus at maturity. To be sure, this tax-neutral rebalancing already exists in regular multi-asset allocation funds and dynamic asset allocation funds.

Any capital gains from lifecycle funds will be taxed on a par with those from equity funds. Funds will take arbitrage positions up to 50% in the final years to maintain equity tax treatment as the target year approaches. So gains after one year of holding will be taxed at 12.5%. If sold within a year, gains will be taxed at 20%.

What makes lifecycle funds different

Life cycle fund

*Comes with pre-determined maturity date, targeted for goals.

*Automatically de-risks portfolio as maturity date nears.

*Rebalancing within fund means no tax leakage, investor pays tax only at maturity.

*1-3% exit loads apply if sold within three years.

Regular fund

*No specific maturity date, leaves timing of exit to investor

*Maintains static allocation throughout

*Shifting from one fund to another for rebalancing attracts tax

*Up to 1% exit load if sold within 1 year

Lifecycle fund is for you if

*You have a specific goal or target year in mind

*Want the asset rebalancing to be managed for you

*Cannot stay committed, prone to emotional decisions

*Can’t decide what is right asset allocation for you

Lifecycle fund is not for you if

*No specific goal or target year in mind

*Want to take control of asset allocation occasionally

*Have reasonable grip over your emotions, can stay invested throughout

*Have a fix on what asset mix suits you

Distinct strategies

That doesn’t mean lifecycle funds across fund houses are identical. Two offerings by two different fund houses targeting the same year may be structured differently, i.e. their individual asset choices may vary materially. Current rules leave an open canvas for lifecycle funds’ risk positioning. “Two lifecycle funds of the same vintage can invest very differently. The regula tor (Sebi) imposes restrictions only on the wider asset allocation. Even asset allocation bands are quite wide,” points out Deepesh Raghaw, Founder, PersonalFinancePlan.in.

There are no restrictions on market cap exposure. Some funds may take a sharp mid- and small-cap tilt within equities. In the bonds portion, rules mandate credit quality of AA or higher, with residual maturities below the fund’s target date. But there are no limits on the duration risk (longer- or shorter-maturity bonds) the fund can take. So funds may take higher duration risk in pursuit of higher return. These differences can lead to varying levels of risk and return.

At Zerodha MF, its existing lifecycle funds adopt a passive-only approach to as set selection. On the equity side, these track the Nifty LargeMidcap 250 Index. ICICI Prudential MF will actively manage its upcoming lifecycle funds. Within equities, it will invest across market caps. In bonds, it will pursue a mix of accrual and duration strategy. Costs will vary accordingly, as will return experience.

One-size-fits-all

Lifecycle funds offered by fund houses come with a minor deficit. Funds with the same time horizon offer similar asset allocation. This ignores the finer differences in people’s risk appetites. Even if two persons targeting retirement 20 years away have the same tar get year, their individual risk tolerance may differ. One may have the capacity to take on higher equity exposure, while the other feels uneasy with a modest equity allocation.

Saraogi reckons how a lifecycle fund will work in conjunction with the rest of the indi vidual’s portfolio also matters. “Somebody could have a very high equity allocation in the other part of their portfolio. For them, coming into the lifecycle fund may be well suited, as it will reduce their equity share, at least in that sleeve. But an investor who is very minimally exposed to equity otherwise in their portfolio could actually run a much higher equity strategy than what a lifecycle fund will permit,” he adds.

No course correction

This may also take control away from the investor. Since the fund remains wedded to its asset allocation, it prevents the inves tor from taking advantage of temporary market distortions. Raghaw argues, “The lack of any dynamic allocation choices is a drawback. The glide path follows a calendar and not the market conditions.”

In a sharp market correction at age 50, an investor will not be able to temporarily hike allocation to equities. In an overheated mar ket, he/she will have to sit through whatever equity allocation the fund runs with in that period. However, exercising some discretion can materially improve outcomes. “When valuations are flashing deep red or deep green, we exercise our choice of actively modifying asset allocation,” asserts Joshi.

But Saraogi feels this rigidity is an advantage. “A lifecycle fund not being re sponsive to market movements is actually a strength—because more often than not, investors delay making the right asset al location decisions, thinking there will be a better time to do it.” The pre-defined asset allocation glide path, while restrictive, can prevent financial ruin, admits Raghaw.

The targeted approach of the lifecycle fund doesn’t allow for deviations either. Even if the investor initially targets a specif ic year that aligns with a goal, circumstanc es may change over time. One may need to dip into the corpus earlier than envisaged. “Life is unpredictable. The investor’s goal post can shift due to circumstances. An op portunity to launch that startup may come earlier than anticipated. An expense may come sooner than budgeted for,” notes Joshi.

Taking the foot off the pedal

Further, formula-driven allocation can sti fle wealth creation, planners insist. When targeting a goal like retirement, a lifecycle fund treats the year of retirement as a single exit point. It provides for cutting down equi ty exposure to as low as 5% by the final year.

This may not be desirable for the longevity of your nest egg. “In retire ment, you have 30-40 years of expens es to provide for. You may need more of equity, not less,” Shah avers. You may have to set up a sys tematic withdrawal plan at the time of fund maturity, which will provide recurring payouts while allowing the remaining corpus to stay invested.

Besides, paring back equity exposure too early could limit upside participation, putting a lid on returns. In financial planning, investors are often used to building in a 12% re turn estimate for their equity allocation. But in a lifecycle fund, the early shift away from equities will keep the return profile suppressed. “De-risking may start too early in a lifecycle fund,” contends Shah. “Investors al ready struggle achieving the desired corpus. Moderating equity exposure too early can leave an even bigger shortfall.”

The timing of equity moderation may also work at odds with your in vestable surplus, suggests Saraogi. “When you are using a very long-dura tion lifecycle fund, it will start equity heavy exactly at the time when your contributions may not be quite large— because you are early on in your ca reer. And as your income grows, your investable surplus increases, but your contributions to the lifecycle fund will progressively be less in equity.”

Rather, it may be advisable to contin ue with a higher equity allocation well into your later years, when larger sums can be deployed for compounding.

Who should go for it?

Experts maintain that lifecycle funds serve very specific individuals. “Its auto-pilot approach is a good option for people low on investing discipline or understanding complexities,” Shah says. It will also work well for individuals who have so far avoided equity investing in any form. Saraogi feels it is a nice solution for investors who want a hands-off approach and a low maintenance portfolio, and for those for whom decisions about asset allocation are a huge cognitive burden.

For investors already on a goal based diet, moving to lifecycle funds is not warranted, feel experts. “Investors already doing goal-based investing can skip lifecycle funds completely because the idea behind the lifecycle fund is already incorpo rated into the portfolio,” says Saraogi. If you are comfortable with your current investment approach and confidently manage your portfolio, there is no need for lifecycle funds, notes Raghaw. However, any fresh allocations towards new goals may be put in a lifecycle fund with a matching horizon.