Investing

Time to spring clean your portfolio

Tax season is over. It’s time for some portfolio spring cleaning. Let’s Roomba this sucker.

We’ve told you before why it’s important to roll over your old 401(k)s and other workplace retirement plans into an individual retirement account (IRA). It usually saves you a bundle on fees and expenses. It gives you access to better investment options. It makes your portfolio more comprehensible and easier to manage. And Mint can get you started. If you’ve worked a bunch of jobs (who hasn’t?) and left a mess of 401(k)s, 403(b)s, and SIMPLE IRAs in your wake, now’s the time to consolidate them. Get it over with.

Even if you’ve been diligent about rolling over old plans, however, you’re probably holding too many mutual funds. Walk into the office of a financial advisor—especially one who works on commission, and you’ll probably be talked into splitting your money among six, ten, twelve funds (I’ve also seen fee-only advisors do the same).

Why do they do this? One reason is that it reinforces the idea that investing is too complicated for you to handle yourself, and you should leave it to the experts who understand the difference between growth stocks and midcap stocks and international REITs and junk bonds. So when it comes time for annual rebalancing, you need to go back to the advisor. Bring your wallet.

Well, this is (to use a technical term) horse poop. We’re going to wean you down to the only funds you really need to get the job done.

Cut the clutter

Assuming you and your spouse work for The Man (i.e., you’re not self-employed), here’s what you should have in your bag of tricks when you’re done rolling over:

  • Two workplace retirement plans (one for each spouse)
  • Two IRAs (one for each spouse)

If you’re single, your investing life is that much simpler. But don’t you long for someone to practice asset allocation with in your twilight years? Don’t answer that.

Now it’s time to decide what mutual funds to put in those accounts. For recommendations, I turned to certified financial planner Allan Roth, author of How a Second-Grader Beats Wall Street and writer of the Irrational Investor blog. You only need three funds, says Roth:

  • A US stock index fund
  • An international stock index fund
  • A total bond market fund

“Those are the three core funds that I get clients as much into them as possible,” says Roth. “These three funds are far more diversified than your 43 funds you have now.”

(If you’re not sure how much to put in stocks and how much in bonds, let me direct you to MintLife’s ever-useful column, The Lazy Portfolio.)

The office

Start with the workplace plans. You’re at the mercy of your pointy-haired plan administrator for fund selection here. A typical 401(k) has a terrifying list of funds with names that make German wine labels look comprehensible. All you care about, however, is what’s cheap. Every fund has an expense ratio which tells you the percentage of your money paid to the fund administrator every year. Look for the word “index” and find the stock and bond index funds with the lowest expenses.

Why? As Morningstar put it, “In every single time period and data point tested, low-cost funds beat high-cost funds.” Morningstar is the company that gives star ratings to mutual funds. In its own study, Morningstar found low expense ratios were a better indicator of success than a high star rating in 58 percent of the test cases. In a workplace plan, an expense ratio under 1% is acceptable, under 0.5% is good, and under 0.2% is awesome.

You don’t have to hold all three kinds of funds in your 401(k). My wife’s retirement plan, for example, has excellent stock index funds and a lousy bond fund. So we hold almost entirely stocks in that plan and bonds in our Roth IRAs. The key is to diversify overall, not within each account. “It’s the total portfolio that matters,” says Roth. This also makes it easier to hit the minimum opening balance for the best funds, which is often $3000 or more.

Inviting IRA to the party

For the IRAs, you have your choice of any funds offered by your mutual fund provider. Roth recommends the following Vanguard funds, but all major mutual fund companies have competing index funds:

Name

Ticker

Expense ratio

Category

avg expense ratio

Vanguard Total Stock Market Index

VTSMX

0.18%

1.13%

Vanguard Total International Stock Index

VGTSX

0.26%

1.37%

Vanguard Total Bond Market Index

VBMFX

0.22%

0.94%

 

What about ETFs? What about adding real estate, small-cap value, or commodities? “If you want to, you can specifically tailor your portfolio in various ways beyond those three funds. But you don’t have to,” says Mike Piper, author of many books on investing and writer of the Oblivious Investor blog. “Those three funds are really all you need.”

Now you can get back to the important things in life, like thinking of more “asset allocation” puns.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster. Mad props to his two favorite investing books, The Elements of Investing and The Bogleheads’ Guide to Investing, for inspiring this column.