A “Total Portfolio Approach” and Why It Is Important

Most investors have more than one investment account. They may have an employer’s 401(k), an IRA rollover, a Roth IRA, a joint taxable account and a college 529 plan. Some accounts, such as retirement accounts, all have the same goal, while other accounts, such as a joint taxable account or a college 529 plan, may have different goals. Cash flows, or deposits or withdrawals, from various accounts may be different too. For those with multiple investment accounts, a “Total Portfolio Approach” will help establish an asset allocation as well as an asset location strategy.

  • Asset allocation influences long-term expected returns and volatility.
  • Asset location influences liquidity and income tax efficiency.

For example, an investor may determine that an asset allocation of 70% stocks, 25% bonds and 5% money market funds is ideal for long-term expected returns and volatility.

Does this mean every account will have the same asset allocation? Maybe not. First, the employer 401(k) plan may have a Stable Value Fund, which is attractive but not available in the other accounts. The 401(k) plan may not have a good U.S. small company fund or international fund choice. The Roth IRA may be the last asset to tap into and possibly leave as an inheritance, so more aggressive investments may be appropriate. An investor may need a large cash balance in the joint account to pay for a lump-sum expense within the next year, such as a new car or wedding. The beneficiary of the college 529 plan may be in high school now and the investor doesn’t want to risk a 20% drop in the stock market when the student is a senior in high school.

Implementing the target asset allocation in this case may mean:

  • A higher allocation to bonds in the 401(k) to take advantage of the Stable Value Fund
  • A larger allocation to stocks in the rollover IRA, including U.S. small company or international funds that are better than the 401(k) choices
  • A more aggressive long-term Roth IRA strategy that is more than 75% in stocks
  • More than 5% cash in the joint account to cover the new car or wedding
  • A higher bond or cash allocation in the college 529 plan to minimize stock market risk

Using this asset location strategy will improve liquidity because there will be more money market funds in the joint account and college 529 plan, and it will be possible to withdraw from these for short-term needs.

Asset location can also optimize tax efficiency by having high-income or tax-inefficient investments (such as real estate, commodity or inflation-protected bond funds) in a tax-deferred account such as the IRA rollover or Roth IRA.

Investors should focus on what they can control. Investors cannot control the short-term direction of the stock market or interest rates, but they can control their asset allocation and asset location. A Total Portfolio Approach increases the likelihood that an investor will achieve their personal financial planning goals.

 

About Bruce J. Berno, CFP®

Bruce J. Berno, CFP® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.