Bill Dyszel, a communications executive in Manhattan, plunked his 401(k) savings into a single mutual fund. Hannah and Mike Resig of Falls Church, Virginia, did the same. Dyszel, 57, chose the Fidelity Freedom 2025 Fund, and the Resigs, both 25, opted for the American Funds Target Date Retirement 2050 Fund—both known as a “target-date” or “life-cycle” fund. (The years —2025, 2050—stand for retirement dates.)

According to Morningstar, contributions to this type of funds have soared in recent years to $420 billion—double what it was five years ago.

The basic strategy behind a target-date fund is to provide a well-diversified portfolio that starts off aggressively and then, as time rolls on, shifts to a more conservative strategy. Thus younger investors, like the Resigs, wind up with mostly stocks and few bonds. Older investors, like Dyszel, who are closer to retirement, carry more bonds and fewer stocks. The ratio of stocks to bonds shifts automatically each year. Estimate your retirement date and a formula does the rest. One reason for these funds’ popularity is that in 2007 the Department of Labor passed a regulation that led many employers to use life-cycle funds as the defaults in 401(k) plans. If workers fail to make another choice, contributions to 401(k) go directly into a life-cycle fund. But the rise in assets is attributable to more than this ruling.

Dyszel chose the life-cycle option for its simplicity. “I didn’t want to spend time figuring out what to invest in and when to invest it,” says Dyszel. For the Resigs, just starting to build wealth, the life-cycle option seemed too sensible to resist. “These funds take into account that when you’re younger, you can afford to take more risk,” says Hannah.

Jerome Clark, portfolio manager of T. Rowe Price’s line-up of retirement funds, says that 90 percent of his savings is in his employer’s life-cycle option. “These funds are a great core holding for almost everyone,” says Clark. “Many younger people invest too conservatively, while many older investors invest too aggressively. With life-cycle funds, the allocations for investors vastly improve.”

Interested in life-cycle funds? “These funds are the easiest investments you can make, but you still need to do research to make the best decision,” says Clark. Some key considerations:

1. Study the strategy.
While all life-cycle funds start off aggressively and then grow more conservative, the rate of progression varies widely. The Fidelity Freedom 2025 Fund is currently 60 percent in stocks, while American Funds Target Date Retirement 2025 Fund and T. Rowe Price Retirement 2025 Fund are both 75 percent in stocks. If you like a fund company but find their mix too aggressive, simply choose a target date closer to home—for example go with the 2015 fund, rather than the 2025 fund.

2. Look carefully at fees.
Life-cycle funds charge fees that can vary considerably. According to Morningstar, the average life-cycle fund charges 1.08 percent a year in management fees. Other options in your 401(k) plan may be much less expensive. If that’s the case, “ask yourself how much the simplicity is worth to you,” says Everette Orr, a fee-only financial planner in Virginia.

3. Consider the mix.
Look at the fund’s diversification (does the stock portfolio have U.S. and international exposure?), the strength of management (how long has it been around?), and historical performance.

Easy-As-Pie Investing The Saturday Evening Post

In hindsight that was a clever move because not only are bonds less volatile than stocks but their value has risen steadily with the decline in interest rates. But with interest rates at historic lows, those gains won’t—in fact, almost can’t—continue, says Dirk Hofschire, senior vice president of asset allocation research for Fidelity Investments. He predicts that the safest bonds—U.S. Treasuries—are likely to pay just enough in the next decade to keep up with inflation.

Time to get out of bonds? Not so fast, says Hofschire: “The situation argues for realistic expectations not for the abandonment of bonds, and perhaps a portfolio with a good mix of bonds still has much to offer.”

The key word here is “mix.” If Treasuries are paying a paltry two percent, the strategy calls for diversifying. Bonds come in all flavors, just like stocks do.

“Complementing high-quality bonds with a variety of other sectors can help you increase your yield and return potential while protecting against risks such as potentially higher inflation,” says Hofschire.

Treasury bonds are available in both conventional form (with steady coupon payments) and inflation-adjusted (lower, fixed coupon payments but regular adjustments for inflation). Include both in your portfolio. In addition, consider the following:

• High-quality, “investment-grade” corporate bonds. These typically yield about 1 percent a year more than Treasuries.

• Municipal bonds. Historically, bond issues by cities and state governments haven’t paid as much as Treasuries. But right now they are about on a par—and, of course, the difference is that interest on municipal bonds is generally tax-free, making their effective return greater than Treasuries.

• Corporate high-yield bonds. Issued by less-than-financial-powerhouse companies, these bonds are riskier than the others mentioned above but are now paying about 3 percentage points a year more than Treasuries.

• Emerging-market bonds. Issued by countries such as Brazil, Russia, and Turkey, the bonds are now yielding a rate similar to corporate high-yield. These, too, carry risks, but offer good diversification power.

Within each bond sector you can further diversify by choosing a mutual fund or exchange-traded fund that allows you instant ownership of hundreds or more of individual bond issues. The strategy is crucial when investing in options like high-yield (aka “junk”) bonds, where the default of any one bond is more than a remote possibility.

Finally, it may be time for even the most conservative investor to venture cautiously into other areas. Consider lowering your bond exposure by investigating vehicles that pay higher interest rates, says David Lambert, founding partner and wealth advisor with Artisan Wealth Management of Lebanon, New Jersey. “For many of our clients we have lowered the overall allocation of bonds and replaced them with other income-producing holdings such as real-estate investment trusts and dividend-paying stocks.”

But sound money management will always dictate holding some bonds. As Lambert points out, even the largest and most stable stocks tend to be more volatile than bonds.

Taking Stock of Bonds The Saturday Evening Post

A rash of media stories called for abandoning the diversified portfolio, rejecting buy-and-hold investment, or adopting new tactics, such as market timing (jumping in and out of the stock market in the hopes of buying low and selling high) and cherry-picking (banking on one or possibly a handful of investments that you think will do better than all the others out there). Other stories have advocated just keeping your money under the proverbial mattress.

Investors are listening. According to the investment resource Morningstar, $573 billion in cash flowed into low-yielding but secure money-market funds in 2008 when the stock and bond markets (other than Treasury bonds) were suffering the most. As soon as the stock and bond markets started to come back in 2009, so did the investment money.

We’re here to tell you that you might want to think twice before following the pack and abandoning the tried and true—the well-diversified, broad portfolio of stocks and bonds and cash that you pretty much buy and hold—and jumping onto any bandwagon that promises to do better. Here’s why:

1. Cash is costly. Keeping your money in cash (money-market funds, savings accounts) may spare you from market volatility, but in the long run, the return on a diversified portfolio of 60 percent stocks and 40 percent bonds still clobbered cash. According to Morningstar, the respective 30-year returns on the diversified portfolio, after accounting for inflation, were three to four times that of a portfolio held in cash.

2. Markets are unpredictable in the short run. If you’re thinking that you’re going to keep your money in cash and pop into the markets at just the right time, think again. Pro investors often can’t even time the markets, says Cathy Pareto, MBA, CFP, president of Cathy Pareto & Associates, a wealth management firm based in Coral Gables, Florida. “Studies show that investors who buy and hold a diversified portfolio, rather than try to rush in and out of investments, tend to do much better.”

3. Specific winners and losers are unpredictable, too. If, instead of diversifying your portfolio, you try to zero in on individual securities or small segments of the market, you may be adding to your risk, but not your return. “People are often overconfident in thinking they can pick one stock or perhaps one industry that is going to do well,” says Don Bennyhoff, CFA, a senior investment analyst at Vanguard Investments. “Professional investors often do a very poor job when they attempt such picks—the average investor won’t even do that well.”

4. Costs are bigger than you think. When you buy and sell (whether popping in and out of the market, or gambling on individual stocks or market sectors) there are substantial costs involved, says Bennyhoff. The “spread” (the middleman’s cut) on stocks can be as high as several percentage points. There is often a commission or markup to pay the broker on any trade of a stock or bond, and fees on fund swaps are not uncommon. You may also pay higher taxes on a shifting portfolio than on a buy-and-hold one.

5. Look at the bottom line. The downturn of 2008–2009 was unusual in the manner in which so many investments, and entire classes of investments, turned sour at the same time. Still, diversification paid off, assures Bennyhoff. Bonds overall didn’t do quite so bad; some bonds, namely Treasuries, did very well. Certain segments of the stock market even shot off like rockets in the second half of 2009. Overall, if you had a highly diversified portfolio of 40 percent bonds, 30 percent U.S. stock, 20 percent foreign stock, and 10 percent cash, your portfolio on September 30, 2009, would have earned you 4.25 percent annually, or 51.63 percent cumulatively, over the prior decade. “Despite what you may have read, diversification and patience hasn’t entirely let us down,” says Bennyhoff.

Russell Wild, MBA, is a NAPFA-registered financial advisor who has written nearly two dozen books, including Index Investing for Dummies and Bond Investing for Dummies.

Why It Pays to Diversify The Saturday Evening Post