Retirement accounts spread thin
We have five different retirement accounts. Should we diversify each account separately or all the accounts overall?
By Walter Updegrave, MONEY Magazine senior editor

NEW YORK ( - My wife and I have a total of five different retirement accounts: two 401(k)s, two Roth IRAs and a taxable account. My question: should we diversify each account separately or have an asset allocation that looks at all the accounts overall?

- B.M., San Marcos, Calif.

I wouldn't go so far as to say that you can't make a case for treating each account individually, or that you'd be courting financial disaster in doing so.

But I'm definitely a proponent of looking at all your retirement accounts together - or what I like to call "the whole enchilada approach."

One big advantage to this approach is that it allows you to better take advantage of the best features of your various accounts. Let's suppose, for example, that your wife's 401(k) has several good large-company stock offerings, but comes up short in the small-cap department. And let's suppose that your 401(k), meanwhile, is chock-a-block with great small-cap funds.

Well, in that case, it would make sense for your wife to forego investing in small-caps in her 401(k) and instead for both of you to get your small-cap exposure in your 401(k).

The Roth IRAs would give you even more flexibility. Perhaps for greater diversification, you want to invest a small portion of your retirement savings in asset classes that have a low correlation to the U.S. stock market - that is, investments such as foreign emerging markets funds and natural resources funds, that tend to zig when domestic stocks zag. A 401(k) may not offer many options along these lines. By opening a Roth account at a decent size brokerage or mutual fund firm, however, you have access to virtually any fund you want.

The other reason I think it makes sense to think of your retirement accounts as ingredients within one big enchilada is that it encourages you to think more about where it's best to hold certain asset classes - a concept known as "asset location" (as opposed to asset allocation).

Some examples

Let's say that you and your wife decide to hold 25 percent of your retirement savings in bond funds. Well, in that case, it makes sense to hold those bonds in a tax-deferred account like a 401(k) rather than in your taxable account where your bond income will get hit with ordinary income tax rates that could range as high as 35 percent.

The same goes for high-turnover funds that throw off lots of short-term capital gains that are subject to ordinary income tax rates, and for REITs, since most of their dividends are taxed at ordinary income tax rates rather than the more favorable rate of no more than 15 percent for qualified corporate dividends.

Conversely, stock funds that generate most of their return in the form of long-term capital gains are generally best held in taxable accounts. This is especially true of tax-managed funds, which use specific strategies to minimize taxable distributions. Otherwise, when you sell you're converting a gain that would be taxed at a maximum of 15 percent into one that could face a rate as high as 25 percent.

Now, your ability to maneuver may be limited by how much money you have in your respective accounts. If, say, you've got the big bucks in your 401(k)s and only a small sum in taxable accounts, you may not be able to stuff your taxable accounts with enough of the right sort of investments to make an appreciable difference in your portfolio's performance. No biggie. Do what you can and as your taxable account grows, you can make adjustments.

And you certainly don't want to place so much emphasis on creating the most efficient portfolio that you end up going round in circles or, worse yet, buying investments you really don't need because of some perceived tax benefit. You should make decisions based on investment potential first, then worry about tax bennies and other considerations.

But by giving some thought to putting together the best overall portfolio rather than focusing on each account alone, you increase your odds of ending up with a bigger enchilada at retirement.


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