Imagine for a moment that you're planning to make a stew and that you can shop at three grocery stores nearby. One has exceptional meat, but the potatoes and vegetables aren't anything to brag about. The other two have high-quality potatoes and veggies respectively, but fall short of your standards on the other ingredients.
Would you buy all the ingredients in each store and cook three separate stews? No. You wouldn't be satisfied with any of them. You would choose the best ingredient each shop has to offer and combine them into one excellent pot of stew.
The same theory applies to retirement investing when you have accounts spread among different employers and investment firms that offer fund lineups with various strengths and weaknesses.
Rather than create discrete portfolios that will each contain subpar investments, you want to pick and choose the best options from each source to build the best overall portfolio you can.
So, for example, if your 401(k) has a low-cost Standard & Poor's-500 index fund, you might favor that fund in that account for your large-company stock holdings and perhaps look to your Roth IRA for a small-cap fund. And if your self-directed pension has a good selection of diversified bond funds, you would want to get your bond exposure there.
Unlike the stew, however, the ingredients of your retirement portfolio won't be simmering in the same pot. They'll be spread out among different accounts. What's important, though, is that this eclectic mix of investments will still work as a coherent portfolio overall, and perform better than the combination of the three separate portfolios you could have built within each account.
That said, taking this holistic approach still may not get you the exact portfolio you would like. One reason is that your ability to invest the right amount of money in the best choices may be limited by the amount of dough you have in each account.
Let's say that based on your age and risk tolerance, you have a target asset allocation of 60% large-cap stocks, 10% small-caps and 30% bonds. And let's further assume that you have $100,000 in total retirement savings divvied up as follows: $70,000 in your 401(k), $20,000 in your Roth IRA and $10,000 in your self-directed pension.
If, as I hypothesized above, your 401(k) has the best large-cap options and your Roth IRA and self-directed pension have the best small-cap and bond offerings respectively, investing your full balance in each account in its best investment would leave you with $10,000 more than you want in both large-caps and small-caps and $20,000 less than you need in bonds. It would also leave you with a much more aggressive portfolio: 90% stocks and 10% bonds.
So to maintain your asset allocation target, you would have to compromise by investing some of your 401(k) and Roth IRA money in bond funds. Granted, doing so may leave you with a portfolio that contains some funds you're not crazy about. But, as with most things in life, you do the best you can.
Besides, having a bit more money than you would like in one or two less-than-ideal funds isn't likely to derail your retirement prospects. And such a concession is certainly preferable to just pouring all your money into each account's best investments and ending up with an overall portfolio that's distorted.
At some point, you may be able to combine some of these accounts into an IRA rollover or a new employer's plan, although a Roth IRA can't be rolled into a Roth 401(k). (To see what types of rollovers are permitted and which prohibited, check out the table on page 17 of IRS Publication 590.)
If you do end up consolidating accounts, you may find it a lot easier to put together a portfolio with the investments you really prefer.
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