Guidelines for Making Your Allocations

Your allocations should be based on a variety of factors, not just a simple "one allocation fits all people and all situations" formula. Some of the factors that should be considered are your age, risk tolerance, when you plan to cash out, and other assets owned, such as for example, your own home.

It follows that an allocation should not just be made one time and then forgotten. As market, economic, or your personal conditions change, so should your allocations. At a minimum, you should review your allocations once a year. I, on the other hand, probably change mine 3 or 4 times per year because I closely follow the trends that I believe will affect fund performance in the months ahead.

At first blush, it might not seem to make much difference when deciding upon your allocations for a taxable account as compared to those for a tax-deferred account such as a 401k or IRA. Generally speaking, this is somewhat true, but not completely. Here are some specific suggestions for choosing allocations for each of these two kinds of accounts:

1) If you already have certain categories of holdings within one of these types of accounts, you should take that into consideration when allocating funds in the other type. For example, if you already have a large position in an S&P 500 index fund within a taxable account, you might want to avoid choosing a 2nd S&P 500 index fund within your tax-deferred account. This aids in diversification. Also see item 4) below.

2) If you plan to own bond funds in addition to stock funds, it may make the most sense to concentrate your stock funds, which usually pay capital gains and appreciate in value, in your taxable accounts, while focusing your bond funds in your tax-deferred accounts. (An exception is when using tax-free muni-bond funds which are an excellent substitute for taxable bonds in most cases.)

The reason is that since capital gains taxes were reduced in `97, you now pay substantially less in taxes when taxable stock investments are sold. As a result, your gains from any appreciation in stock prices will be taxed at a more favorable rate. When tax-deferred funds are cashed in, on the contrary, they are taxed at the higher rates for ordinary income, regardless of whether the gains came from price appreciation or from dividends. (It should also be pointed out that if you sell stock funds at a loss from a taxable account, you may be able to deduct the loss on your taxes. The same is not true for stock funds in a tax-deferred account.)

It's probably best to put bond funds and other funds with high dividends (but with low capital gains) into your tax-deferred accounts. This will help keep your yearly taxes lower and when you cash out, you may be in a lower tax bracket and thus pay less in tax than you would pay now for the dividends you receive.

3) If you invest in both growth and value funds, you might want to concentrate the growth funds in your taxable account and the value funds in your tax-deferred accounts. The reasons are the same as in 2) above. That is, growth funds tend to generate more capital gains while value funds often have higher dividends.

4) If you decide to own both index funds and managed funds, something I think makes good sense, try to concentrate the index funds in your taxable accounts since as a rule they generate less taxable distributions each year due to low turnover within the fund portfolio. Those managed funds with high turnover rates are most tax-efficient when located within your retirement accounts.

My Overall Personal Allocations

I have already given some percentage guidelines for suggested allocations in Newsletter #1. As you might expect, my own allocations aim to replicate these percentages closely. Here are my own approximate allocations for all of my funds together, taxable and tax-deferred, as of 7-1-99.

My 401k Allocations

If you participate in a 401k or similar tax-sheltered investment program through your work, your fund choices will naturally be affected by the fund options available within your program. I am presenting my choices particular to my work plan because several people at my work have requested this information. However, regardless of where you work, you can use my choices to serve as a suggested allocation if desired, substituting the specific funds available within your plan.

Here are my current allocations for future premiums within my 401k plan:

For these new allocations, I'm overweighting cash until either stocks appear a little less overvalued or bonds appear closer to the end of their current bear market.

In terms of fund categories, these choices are broken down as follows:

Here are my specific fund choices, Morningstar styles, percent allocated, and year-to-date returns as of 7-2-99:

For my existing balances within my 401k, the breakdown is as follows:

Note that my 401k allocations reflect the strategies presented in the "Guidelines" section above. That is, I am not currently allocating any funds, nor do my existing balances hold, any S&P 500 index or company stock. This is because I already own the S&P 500 index and company stock in existing taxable accounts. To contribute more here would, I believe, cause me to be "overloaded" in these categories.

Incidentally, one fund I think very highly of is not included in my current allocations. It is Janus Aspen Worldwide Growth. The foreign component of this fund is very similar to the Janus Overseas Fund which I already own outside my 401k and I do own some Janus Aspen within my existing 401k too. Right now I favor the Templeton Foreign Fund for new investments to my 401k due to its value emphasis, its higher proportion of emerging market stocks, and the absence of large cap U.S. growth stocks in its portfolio.

If you do not want as many funds as I have selected, I would suggest the following slimmed-down version:

Another comment: I highly favor PIMCO Total Return over Fidelity Intermediate Bond. The manager of the PIMCO fund, Bill Gross, is widely recognized as the "Peter Lynch (of Magellan fame) of bond investing". The Fidelity fund, on the other hand, is just so-so at best. The thing to recognize about Intermediate Bond is that it is not really "intermediate" at all, but rather, short-term in make-up (see www.morningstar.net). Therefore, ironically, it may actually perform better than PIMCO in the immediate future within the current rising rate environment.

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