Getting your IRA mix right

To get the correct asset allocation, you first have to know what you own.

By Walter Updegrave, Money Magazine senior editor

NEW YORK (Money) -- Question: I rolled my 401(k) from a previous employer into an IRA three years ago and think I need to take a fresh look at the asset allocation.

Right now I've got about 29% in two growth funds, 15% in a capital appreciation fund, 14% in mid-cap value, 13% in a global fund, 12% in another stock fund, 9% in a high-yield bond fund and 8% in a total return bond fund.

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I'm still 20 years from retirement and want to take a fairly aggressive approach to my investing. What do you think of my current mix and do you have suggestions for how I might improve it?

- Joe Farah, Diamond Bar, Calif.

Before we can talk about improving your investing approach, you've first got to know what you're doing now. I can see that you've invested your IRA money in eight different funds, six stock and two bond funds. And on the face of it, that might seem to be a pretty well diversified portfolio.

But in fact, it's hard to tell how your IRA is really spread among different types of stocks and bonds. To determine that - and to get a realistic sense of the balance between risk and potential reward in your portfolio - what you really want to know is how your stock holdings overall are divided up both by size (large-, mid- and small-cap stocks) and by investment style (growth vs. value).

In the case of bonds, you want to know about the credit quality of the bonds (high-quality vs. junk) so you know the risk of default as well as the maturity (long-, intermediate- or short-term), which tells you how much a bond or bond fund's value is likely to go down if interest rates rise (or rise if rates fall).

I can get a sense of that sort of information in the case of a couple of your funds (mid-cap value and high-yield bond). But for the others, the information is spotty. For example, a term like "capital appreciation" tells you zip about what sorts of stocks a fund manager actually buys. The same goes for a "total return" bond fund. That could mean just about anything.

All of which is to say that if you want an accurate sense of how your money is invested, you've got to look beyond vague or very broad descriptions (a global fund generally can and does own both foreign and domestic securities in any variety of proportions) and you certainly can't go by the name the fund company slaps on, which usually is driven more by marketing that a precise description of investing style.

X-Ray Your Portfolio

So how do you get that accurate sense, and then go on to fine tune your mix?

You can start by going to a tool like Morningstar's Portfolio X-Ray, which you can get access to at the Investment Planning Tools section of the T. Rowe Price site. (To use the tool, you'll have to register, but there's no charge for doing so. Alternatively, you can use a scaled-down version called Instant X-Ray without registering.)

Once you get to Portfolio X-Ray, you simply plug in your individual fund holdings along with the amount that you have invested in each one and as Emeril would say, Bam! You'll get an overall view of how your portfolio is divvied up. While you're at it, you can also check out other sorts of worthwhile info, like the annual expenses you're paying.

You might find that that even though you own, say, six stock funds, your holdings are actually concentrated mostly in domestic large-company stocks with very little exposure to small-caps.

Once you know how your money is actually divvied up, you can then evaluate whether that mix makes sense given such factors as your age, your tolerance for risk and your investment goals.

The easiest way to do that is to compare your portfolio's mix of stocks and bonds to what's generally recommended for someone your age or with a similar appetite for risk. So, for example, you could go to our Asset Allocator tool and compare the portfolio mix guidelines you get there vs. what you already have.

Compare your portfolio

Another way to go is to compare your portfolio to the asset allocation in a target-date retirement fund aimed at someone your age. Since you plan to retire in about 20 years, you might compare your portfolio's mix to that of a 2025 or 2030 fund - that is, funds that have a mix of assets that's appropriate for people who plan to retire in 2025 or 2030.

T. Rowe Price's 2030 fund, for example, has about 9% of its assets divvied up between investment-grade and high-yield bonds, some 14% in international stocks and 77% spread among domestic stocks, including large and small shares, growth and value.

A number of fund companies offer target-funds these days, including such biggies as Fidelity, T. Rowe Price and Vanguard. (More and more 401(k)s are also making target retirement funds available as well.)

Now, I'm not saying that your portfolio has to match the allocation you come up with at our tool or that it must be a mirror image of any fund company's target fund. There's no single portfolio allocation that's "correct" for all investors, even of a given age. (Indeed, you'll see that even the allocations among target funds will vary from company to company.)

But at least you'll have a good benchmark. If you feel (as you apparently do) that you can take on a bit more risk for the possibility of higher long-term returns, then you could devote more money to stocks, and perhaps a bit more to specific types of stocks such as growth issues or small caps. On the other hand, someone who gets anxious every time the stock market takes a dip might want to go with a slightly more conservative mix by devoting more to bonds.

That's a personal decision, although I'd advise against going overboard either way.

By the way, once you set your mix, avoid the urge to change it every time the financial markets make a move. Remember, the purpose of asset allocation is to give you a good shot at competitive returns with a reasonable level of risk given the inherent uncertainty of the financial markets. If you start tinkering with your allocation or worse yet radically revamping it on a regular basis, you'll be undermining your long-term strategy.

So set your mix and leave it alone, except to bring it back in line about once a year or so. Follow that strategy and who knows, maybe you'll even be ready to retire sooner than you'd planned.


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Ask Walter a question: Click here or e-mail us at asktheexpert@turner.com.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.