What is an asset allocation fund?
An asset allocation fund is a mutual fund with both stocks and bonds presented as a one-stop shopping solution to your portfolio management needs. While some such funds use the words “balanced” or “equity income” in their names, many get right to the point and use terms like “conservative”, “moderate” or “aggressive”. The selling point of such funds is the ease with which you can find a fund whose name suggests suitability to your risk profile.
Some asset allocation funds have teams of portfolio managers who analyze and select individual stocks and bonds. Many invest in other mutual funds; usually one or more stock funds and one or more bond funds. In general, conservative allocation funds will have a higher percentage of assets invested in bonds than stocks. Aggressive allocation funds will emphasize stocks. Moderate funds sit between the other two in terms of allocation.
Why you should avoid asset allocation funds
Lack of flexibility
If you devote all assets to an asset allocation fund, regardless of what you might feel about the markets or world, the allocation of your assets is set by formula. You have no control. In fact, even if you decide to pay higher fees to own allocation fund shares guided by a professional money manager, that manager also has scant control over the asset allocation.
High fees for service provided
Asset allocation funds consist of both stocks and bonds. Although bonds involve less active management and usually incur lower fees, most asset allocation funds charge high equity-level expense rates for the entire balance. Further, many asset allocation products are “funds of funds”. They achieve their target allocations by shifting money between stock and bond funds, engendering multiple layers of fees and lack of transparency.
What you should do instead
If you know enough to pick an allocation fund, you know enough to allocate your assets. If you lean toward a conservative allocation fund, consider putting between 70% and 80% of your assets in bonds or bond funds and the rest (20%-30%) in stocks or stock funds. If you’re on the aggressive side, reverse that mix. If you are moderate, keep both stocks and bonds in the 40% to 60% range. As time passes, your results and reactions to them may help you refine your percentages toward the upper or lower end of those ranges.
Since asset allocation funds are presented as holistic one stop solutions, the superior replacement strategy is a rational investment program.