Q. Vanguard recently started a new fund class, Target Retirement funds. Each fund is pegged at a person's expected year of retirement. The funds automatically balance their holdings among U.S. stocks, foreign stocks and bonds in a mix appropriate to the retirement year. The expense ratio is 0.2 percent, which compares very well with its other index funds. My problem with being a Couch Potato is that I am too much of one. I forget to rebalance at the end of each year. This Vanguard product seems like a good thing to me. Any comments? ---E.F., by email from Dallas

A. Vanguard isn't alone in this game. The three biggest funds in this arena are Fidelity funds for 2010, 2020, and 2030. T. Rowe Price is in the game, too. A recent survey showed that this type of fund was popular with 401(k) plan sponsors. It will become more popular as plan sponsors deal with issue of default choices for these plans.

Basically, they are a good idea. They simplify your decision-making.

Different fund companies, however, have different ideas about what your asset allocation should be at different ages. The current total equity commitment of the year 2020 funds from Fidelity, T. Rowe Price, and Vanguard ranges from a low of 68.4 percent (Fidelity) to a high of 77.2 percent (T. Rowe Price).

I think risk-measured portfolios are a better choice. In those, you select a level of risk you are willing to take and then stick with it. You might, for example, pick the T. Rowe Price Capital Appreciation fund (ticker: PRWCX). In Morningstar language, this is a "moderate allocation" fund with a traditional 60/40 mix of equities and fixed-income. A more risk-averse investor might choose Vanguard Wellesley (ticker: VWINX), with only about 40 percent of the portfolio in equities.

Selecting your own allocation is important for two reasons. First, you might be more, or less, willing to take risk than the cookie-cutter asset allocation of your retirement year portfolio. Second, some people know they will be receiving a pension from their employer. With this additional source of retirement income, they can afford to take more risk than if their savings alone were responsible for their retirement security.

Q. I manage my own portfolio (I am a retired engineer, born in 1935), which is worth $1.2 million. As it gets larger, I am getting worried about asset allocation. By all accounts this seems to be very important, but neither you nor other writers discuss it very much. Do you know where I can get some help on this?

I prefer to buy only mutual funds, and I also prefer to pick my own funds. I am not willing to give up 1.5% to have others manage my money. ---H.B., by email from Nashville, TN

A. Just as you can get into plenty of arguments about how to select stocks, you can get into endless arguments about how to do asset allocation. When it comes to retirement income, however, pragmatic studies of portfolio survival indicate that you'll be able to take the largest amount of income for the longest time if your allocate 50 percent to 75 percent of your portfolio to equities.

A discipline called Modern Portfolio Theory (MPT) also suggests that your portfolio should be diversified with international equities, REITs, and funds that invest in both small-cap stocks and value stocks. The basic idea is to get the highest possible return with the lowest possible risk, measuring the risk by price fluctuations. Here is a partial list of asset classes that most financial planners use for portfolio construction:
  • Money market funds (cash)
  • Intermediate-term, domestic fixed-income funds
  • Large-cap domestic equities
  • Large-cap international equities
  • Small-cap domestic equities
  • Value-priced domestic equities
  • REITs
What portfolio designers look for are asset classes that are negatively correlated---i.e., when one goes up, the other goes down. Do this with two asset classes that have the same long-term return, but tend to move in opposite directions, and the risks will tend to cancel out--- but you'll capture the return.

Like most things in life, this is easier to say than do.

If you'd like to learn how others do it, you might start reading about funds that are called asset allocation funds. In Morningstar language, these funds are divided into three categories: conservative, moderate, and world allocation funds.

You'll find a lot to read on my website (www.scottburns.com) simply by using the search tool and entering "asset allocation." You should also explore the category called "The spenders' portfolio and portfolio survival."