Q. Can you talk about the pros and cons of creating your "five-fold" portfolio vs. investing in a targeted retirement mutual fund? Could you also touch on the practical aspects of trying to create and rebalance a "five-fold" portfolio with a variety of accounts (401(k) s, Roth IRAs Traditional IRAs and taxable accounts) at different investment companies. I've considered consolidating my 401(k) s into existing IRAs at one firm but like the reduced fees, distribution flexibility and borrowing capability associated with the 401(k) s. I think you once wrote a column about the benefits of diversifying accounts as well as investments.
---B.R., by email from Texas
    A. The “five-fold” portfolio is one of the Couch Potato Building Block portfolios. It is constructed with inexpensive index funds or ETFs and represents a moderate level of portfolio risk that remains constant.

    The Target Retirement Funds--- now available from many mutual fund companies--- are a great example of how marketing trumps actual thought in the financial services business. While their actual asset allocations differ, the common feature of these funds is that they suggest holding lots of equities when you are young and fewer when you are old. This is the conventional wisdom, but a growing body of research suggests it is wrong.

    Equally important, the implicit assumption in creating a time-dated mutual fund is that the cookie cutter approach will be appropriate for every person and household, regardless of the differences in their circumstances. In fact, there are gigantic differences between people during their careers and at retirement. The differences should be reflected in the allocation of financial assets.

    We accumulate financial assets because we eventually have to replace our faded human capital--- the skills, talent, and energy we bring to the workplace as young workers. How our savings are invested needs to reflect the security and prospects of our work and our age. You can’t do that with a cookie cutter target fund.

Here are some examples:

    --- In your twenties you should be more conservative with your investments because your career is uncertain and you are faced with a major series of expensive projects. Paying for education loans, getting married, buying a house, etc. So it’s better to take a bit less risk in your investments to support your mobility and career uncertainty.

    --- In your thirties and forties you should be most aggressive with your investments because your employment is relatively secure, you’ve bought a house, and you may be able to take more risk. Even there, a tenured college professor can take more risk than a high tech sales manager.

    --- In your fifties you need to dial back your risk because you are more vulnerable on several fronts. The fifties is a period of substantial life risk--- health, marriage, employment and career.

    --- In your sixties the amount of risk you take will depend on what retirement resources you have and when you intend to use them. A worker who will have a pension, for instance, should be a more aggressive investor than a worker who has only a 401(k) plan. A worker who retires without paying off a home mortgage should be more cautious than one who has no mortgage. A lower income worker with Social Security benefits, a pension, and a mortgage free home can be more aggressive than a high income worker who will depend on investments for the bulk of her retirement income.

The cookie cutter target funds don’t take any of this into consideration.

    That’s why I favor the construction of portfolios that fit your particular circumstances and risk tolerance. You should also know that I didn’t pull these ideas out of thin air. They are based on following the best research available, including work by Nobel laureate Paul Samuelson. That research is now moving out of academia toward practice. The best recent example is a study funded by the Research Foundation of the CFA Institute. “Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance” by Ibbotson, Milevsky, Chen and Zhu shows why the cookie cutter approach of the Target Retirement funds is sloppy personal finance. (The book is now available as a $35 paperback through Amazon. It’s not an easy read, but it should be required reading for financial planners. )

Trust me; it will be ten years before the folks in mutual fund marketing hear about it.

If you keep your portfolio relatively simple--- and you can do that with 5 asset classes--- you will have no difficulty duplicating the same portfolio in several accounts.

On the web:

Lifetime Financial Advice at Amazon:

Lifetime Financial Advice in pdf Form for Free:
Learn about the Couch Potato Building Block portfolios here: