I use your investment strategy for my Roth IRA and Rollover IRA.  My current employer uses Prudential for my company’s 457 plan.  Looking at the options, I cannot seem to use your allocation strategy due to a lack of choices.  Do you have any suggestions?

A recurring theme in most plans is a limited number of investment options.  This restricts your ability to properly allocate and diversify your account.

If you find yourself in this situation the allocation tactic described below is a simple and practical way to get your portfolio on track.

First, use the table below to identify any asset classes that are missing in your plan.  Put a check next to each asset class that is available in your plan.  (To determine the asset class of a particular fund go to Morningstar.com and enter the fund’s name in the search box.  The asset class will then be indicated in the category field.)

ASSET CLASSAGGRESSIVEMODERATECONSERVATIVE
Large Cap Blend10%6%4%
Large Cap Value10%6%4%
Small Cap Blend10%6%4%
Small Cap Value10%6%4%
REITs (Real Estate Investment Trust)*10%6%4%
International Large Cap Blend10%6%4%
International Large Cap Value20%12%8%
International Small Cap10%6%4%
Emerging Markets10%6%4%
Short-Term Bonds0%12%18%
Intermediate-Term Bonds0%20%30%
TIPS (Treasury Inflation Protected Securities)*0%8%12%

*REITs and TIPS should only be used in tax-deferred accounts.

The asset classes without check marks represent the areas you need to invest outside of your employer’s plan.  Note: if you are utilizing an aggressive allocation strategy, don’t worry about the bottom three asset classes.

To keep things simple I will give you an example assuming the following:

  1. You have $100,000 split between your company sponsored plan and an IRA.
  2. You are utilizing an aggressive allocation (no fixed-income funds).
  3. You went through the above checklist and determined your company plan offers funds in the following asset classes:
  • Large Cap Blend
  • Large Cap Value
  • Small Cap Blend
  • Small Cap Value
  • REITs.

Based on the third assumption you need to invest in the following asset classes in your IRA:

  • International Large Cap Blend
  • International Large Cap Value
  • International Small Cap
  • Emerging Markets.

Ideally you would be able to utilize all of the above asset classes in each of your accounts.  Since you are unable to do so I think it is important for you to understand the pitfalls of splitting the asset classes amongst several accounts.

The first thing to be aware of is that – using the above scenario – your company plan and you IRA will behave differently.  Certain asset classes, such as emerging markets and international small cap value, are more volatile than, for instance, large cap blend.  Concentrating the more volatile asset classes into one account – in the above example the IRA – increases the relative volatility of that account.  This makes looking at both accounts as one portfolio imperative.  Otherwise you may be tempted to reduce your equity holdings in the more volatile account in times of market stress and do the same thing in the less volatile account when markets are performing well.

To the extent that you can evaluate the totality of your accounts and regard your overall portfolio as having one return, you should be able to improve your long-term returns and control your risk by building a well-diversified portfolio across multiple retirement accounts.