A comparison between two approaches to life-cycle investing

This paper examines industry’s approach to changing asset mix as the maturity of an investment nears. We examine two types of mutual funds to determine if they are consistent with academic work on maximizing return for a given risk tolerance. One class of funds (date-targeted) changes the asset mix through time without independently evaluating the investor’s tolerance for risk while the other class of funds (risk-targeted) attempts to match the client’s risk tolerance but it does not automatically adjust the asset mix as the liability associated with the investment nears. Both fund classes are evaluated using the Markowitz mean variance framework and Kahneman and Tversky’s prospect theory. In both cases, we consider human capital in the portfolios. We find it difficult to justify the prescribed asset mix for investors with less than a ten year investment horizon and propose areas for further research.