Many people look at retirement accounts individually instead of as a part of one overall investment portfolio. This can cause big problems with asset allocation and building a well-diversified investment portfolio. Here is why your overall portfolio needs to be diversified, but each individual investment account does not.
Many accounts, one investment portfolio. It's not uncommon to have more than one retirement account. I have two 401(k)s, a Rollover IRA from an old 401(k), a Roth IRA, a traditional IRA, and a Thrift Savings Plan account from my time in the military. I also have several mutual funds and individual stocks held in taxable accounts in addition to those six retirement accounts. All told, I have close to 10 accounts that hold my investments. It is important to treat all of your accounts as parts of one investment portfolio, not as individual investment portfolios.
You don’t need to diversify each individual account. It would be extremely difficult, and potentially very costly, to diversify the holdings in each individual account. Fees and commissions would quickly wipe out any gains I made, even if I used a discount brokerage to reduce commissions. Instead of attempting to diversify each account, diversify your entire portfolio. You could, for example, have 100 percent of the assets in your 401(k) in large cap stocks, provided that your other accounts had a range of other investments to balance that out. This is the strategy I use to balance my portfolio. I prefer to put 100 percent of the funds of a smaller account in one asset class and fine tune my asset allocation in my larger accounts. This makes my asset allocation less hands on and saves me a lot of money in transactions and fees. I typically do most of my adjustments in my 401(k) plan, which is in mutual funds and doesn't rack up any commissions when I change my asset allocation.
Target-date funds can be sneaky for asset allocation. Target-date funds, or lifecycle funds, can be a wonderful investment tool for beginning investors and people who don't want to tinker with their investments. But they can also quickly skew your asset allocation. Target-date funds are designed to automatically adjust their holdings based on your target retirement date, not based on the rest of your investment portfolio. Try to find an alternative if you plan on having additional investments in your portfolio or be prepared to adjust your investments often to compensate for the ever-changing makeup of the target-date fund in your account.
Integrate individual stocks carefully. If you choose to invest in individual stocks, then take a look at any mutual funds or ETFs you may have in your portfolio to ensure you are not overexposing yourself to too much risk in any one sector. You should take this a step further and think twice about owning too much company stock, which can be hazardous to your financial health. Your career is already financially intertwined with your future. The last thing you want to happen is to lose your job and half your investment portfolio in the same day, as many former employees of Enron and WorldCom did.
[See 5 401(k) Mistakes to Avoid.]
Many accounts and investments make up one portfolio. Begin thinking about your investment portfolio as one bucket of money. Take some time to consider your investment goals and risk tolerance, design the asset allocation to reach your goals, and then work toward getting all of your accounts aligned with your financial plan.