iFund- Lifecycle Investment(1):From Theory To Application

2019-08-09 04:53
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The life-cycle investment originates from the research on investment decisions at different stages of individual life. it is an adaptive investment strategy for different periods of individual life, and is suitable for investors with more passive pension management decisions. Currently, this strategy has become the mainstream choice of the US pension market, and the default investment strategy (DIS) promoted by the MPFA is also very similar to the life-cycle management concept.


Everyone should be familiar with lifecycle investment. In 2016, the MPFA introduced and promoted the Default Investment Strategy(DIS), which is an investment strategy taking a concept similar to lifecycle.  Lifecycle investments originate from research on investment decisions at different stages of an individual’s life, which could be dated back to the end of the 1960s. Starting from multi-cycle investment theory to life-cycle investment product design, and then to being recognized by investors’ pension institutions, lifecycle investments has experienced a long way in development. From reviewing the milestones in lifecycle investments, readers will understand why this strategy is popular in the US and become the mainstream for the pension market.

Milestones in lifecycle investment

The theoretical study of the lifecycle can be traced back to the article “Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case”, which was written by Robert Merton and published in the Review of Economics and Statistics in 1969. In the study, Merton utitized stochastic dynamic programming to optimize cross-cycle investment and consumption on individual basis, and establish a corresponding analysis framework. This method has been applied to the research on multi-cycle investment for the next few decades. On the other hand, in the investment decision of pension investment and insurance companies, lifecycle investment has gradually become the mainstream idea.

The development of the 401(k) plan, which is an enterprise annuity plan, has provided a practical basis for lifecycle investment. In 1978, the US Internal Revenue Code has imposed new terms and conditions in Section 501(c), if employers such as government agencies, corporations and non-profit organizations established an accumulated pension account for their employees, they are entitled to concessions on tax. The 401(k) plan allows the employee to decide his own investment plan and bear his own risk in doing so. As of the third quarter of 2017, the US pension market has reached US$27.2 trillion, and the total size of the defined contribution plan(DC)and occupation pension has reached US$16.2 trillion.

In 1994, Wells Fargo and other institutions first involved the creation of lifecycle fund, which unveiled the prelude to the operation of lifecycle fund products. Since then, the US lifecycle type fund market has resulted in a “rule of three” pattern. Vanguard, Fidelity and T.Rowe Price account for more than two-thirds of the market shar. Since 2014, Vanguard has surpassed Fidelity to become the largest player in the US lifecycle market, and Vanguard is the only company in the Big Three with an increasing market share.

In order to raise the popularity of defined contribution plan, the US government has enacted the Pension Production Act. The key to the act is to establish a “qualified default investment alternative” mechanism. If the employer chooses an alternative product as the default investment option for an automated DC program participant, the employer will no longer have to bear the entrusted responsibility for the loss of the investment, this greatly increases the motivation of the employers for participating in DC programs and lifecycle products.

Lifecycle products meet the elderly needs

Lifecycle products adopt adaptive investment strategies for different periods and characteristics of each individual’s life, and solves the selection puzzles of the investors in one-stop, which are more suitable for investors with more passive pension management plans. When DIS enters the field of vision of the public investors, I believe we could understand lifecycle investment from the following three perspectives.

  1. Reviewing the history of development of the lifecycle products in US, individual retirement accounts and tax concessions are prominent to the development of lifecycle. From the government perspective, can those basis of lifecycle products attractive investors to participate?
  2. The ultimate goal of lifecycle products is to maximize investor utility through dynamic asset allocation strategies. From a personal perspective, how do lifecycle products optimize the allocation of human resources and financial assets?
  3. Vanguard is currently the leader in the market share of lifecycle funds. From a product perspective, does the cost determine the success of the life cycle fund?How do lifecycle products meet the pension needs of different individuals?

In response to the above three questions, I will introduce to the readers one by one in the next few weeks.

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