Cleaning up a retirement mess

NEW YORK (Money) -- Question: I'm changing jobs and would like to roll over my $150,000 401(k) into an IRA account. Since I already have other IRAs in individual mutual funds, I would like to put those funds as well as my new IRA rollover in one place so I can split the percentages invested in each individual fund just like my old 401(k) with 15 options. Do you recommend this approach? --Randy P., Montezuma, Iowa

Answer: I applaud your instinct to organize your far-flung retirement accounts, but I do have some misgivings about one aspect of your approach.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)

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Let's start with what I think you're doing right -- namely, gathering your savings into one place. Doing that will give you a much better shot at creating a coherent investing strategy, monitoring the progress of your investments and turning your savings into a nest egg that will be able to support you comfortably throughout retirement.

As for your actual plan to instill order -- consolidating your old 401(k) and IRAs under the roof of a new rollover IRA -- I think it's a perfectly acceptable way to go.

If you transfer the money from your old accounts to a rollover IRA at a mutual fund firm that has a diverse roster of stock and bond funds, you should have no trouble putting together a diversified portfolio. If you don't want to be limited to the lineup of a single fund company, that shouldn't be a problem either. In addition to selling their own funds, many major fund companies and investment firms, including such biggies as Fidelity, Schwab and Vanguard, offer access to other companies' funds as well, often at no transaction cost. By going this route, you can build a portfolio by mixing and matching what you believe are the best offerings from a variety of fund families, in effect assembling your own roster of all-star funds.

Where to invest

That said, there is another option you may at least want to consider. Since you're going to a new job, you might be able to move the whole shebang into the 401(k) at your new company. That way, you would not only have your old 401(k) and IRA assets in the same place. You would also have your new 401(k) contributions going into the same overall portfolio as well, making it easier to manage your entire pot of retirement savings. Plus, with most 401(k)s you can borrow against your assets; you can't borrow from an IRA.

Of course, moving everything to your new 401(k) makes sense only if your new employer actually offers a 401(k) and that new 401(k) accepts rollover funds and that 401(k) has enough low-priced investment choices to build a decent portfolio.

On the other hand, it's easier to get money out of an IRA if you really need it, although you may have to pay not only tax but a 10% early withdrawal penalty, unless you qualify for an exception. If you think that will be an issue, you might want to keep some of your savings aside in its own IRA.

There's also another benefit of keeping your stash in an IRA as opposed to moving it to your new 401(K). If you roll over the money into an IRA, you would have the option of converting some of it to a Roth IRA.

How to invest

Whichever way you decide to go, what's most important is that you end up investing your savings in a reasonable way.

I got a little concerned after reading how you want to invest your new rollover IRA. It was unclear to me whether you were saying that you actually split your 401(k) money among 15 options and would like to duplicate that approach in your new IRA, or whether you were merely telling me that your 401(k) offered 15 options from which you could choose.

Either way, I think it's important that you -- and anyone else building a retirement portfolio -- understand that more doesn't always mean better when it comes to investment options as well as the number of investments you put in your portfolio.

Don't get me wrong. Choice is good, up to a point. But having too many choices can be problematic. For example, a study published by Wharton's Pension Research Council suggests that 401(k) participants can feel overwhelmed when faced with too many choices, leading fewer to participate in their plan. Research also shows that the more investment choices they have, the more aggressively some 401(k) participants tend to invest -- i.e., the more of their assets they plow into stocks.

Similarly, I think many investors overdo it with the number of investments they include in their retirement portfolios. That's understandable. After all, 401(k) plans on average offer 20 investment options, according to a recent survey by Hewitt Associates. And if you're investing in an IRA held at a mutual fund company or other investment firm, you have access to literally thousands of funds, ETFs and stocks. The message from Wall Street and the cable TV investment programs is that you should be scooping up these offerings by the handful.

But while there's no "correct" number of investments everyone should own, I can tell you that most people don't need anywhere near 15 different ones in a retirement portfolio to effectively build wealth long-term.

Basically, aside from cash reserves, you need exposure to two main asset classes -- stocks and bonds. If you really don't want to make investing choices, you can get a broadly diversified portfolio in a single target-date retirement fund.

Barring that all-in-one approach, I believe you can easily get by with as few as three funds: a total stock market index fund, a total bond market index fund and an international stock index fund.

If you wish, you can expand your holdings beyond that for additional diversification, maybe adding an inflation hedge with TIPS or a real estate fund or broadening your foreign stake by throwing in an emerging markets fund.

But the point is you don't need to have a representative from every Morningstar fund category in your portfolio. Nor must you make room for every new ETF gimmick marketers churn out.

I'd say once you get beyond five or six well-chosen funds, the additional diversification benefits are minimal, and the more likely you're just creating overlap with what you already have. (To see whether that's the case, you can plug your portfolio into Morningstar's Portfolio X-Ray tool and choose the Stock Intersection tab).

Bottom line: I think you should proceed with your plan to organize your scattered retirement accounts so you can manage them as a unified whole. But don't undermine your effort by then spreading your money among an unwieldy smorgasbord of funds.