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I recently did one of those 401(k) allocation things on FinancialEngines
(it's actually linked to our 401(k) website).
Here is the mix they suggested:

25% S&P 500 Fund (I believe this is SVSPX; SSgA administers the fund.)
25% Moderate Fund (index fund-55% Russell 3000 index, 30% Lehman Bros.
Intermediate Gov/Credit Bond Index, 15% EAFE index)
25% Russell 1000 Value Fund (index)
11% Aggressive Fund (index fund-75% Russell 3000 index, 25% EAFE index)
9% EAFE Fund (index)
5% Intrest Income Fund (GIC's and SIC's)

(I have a small-cap in an IRA)

Maybe somebody with more knowledge/experience than me could comment on the mix.
The 1st thing I noticed is that they recommended all institutional index funds and completely left out all the "name-brand" offerings.
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They seem to recommend what has had the best performance in the past, and things that have a low correlation with each other, with your desired level of risk.

I'm a bit surprised that they split up the Russel 3000 and EAFE among multiple funds. Wouldn't it make more sense to just have separate funds for Russell 300, Lehman, EAFE?
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Don't care for it. Personally, I have almost all of my 401(k) in an S&P index fund, with a very small percentage in company stock. Outside of my 401(k) I have a Roth, invested in a small-cap index and international index. I am shooting for a 60% S&P/22% small-cap/18% international asset allocation overall. I am 34 years old.

Thanks!
Joe
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If your 401K is linked to the Financial Engines site, they gave you the best choices in your plan. The reason FE did not pick name-brand funds is because of the high fees associated with these funds. I would NEVER invest in a managed mutual fund.

If you ever leave your current job, you should roll over your 401K to Vanguard and use one fund: VTSMX. If you have over $150K (or their minimum limit for IRAs) use the Admiral Version of VTSMS which is called VTSAX.

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If you ever leave your current job, you should roll over your 401K to Vanguard and use one fund: VTSMX.

I respectfully disagree. There is no "one size fits all" investing option. You do not know the original poster's age, or goals, or risk tolerance, or desire for "involvement" in their portfolio. To me, that means you do not know enough to make a valid recommendation. If you are invested solely in VTSMX then sure, say so and tell us why. But beware dispensing "investment panaceas". If the original poster was a 60-year-old, with a weak stomach, investing for retirement, then your advice would be horrible IMHO. :-)

Thanks!
Joe
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joebedford wrote:
I respectfully disagree. There is no "one size fits all" investing option. You do not know the original poster's age, or goals, or risk tolerance, or desire for "involvement" in their portfolio. To me, that means you do not know enough to make a valid recommendation. If you are invested solely in VTSMX then sure, say so and tell us why. But beware dispensing "investment panaceas". If the original poster was a 60-year-old, with a weak stomach, investing for retirement, then your advice would be horrible IMHO. :-)

I respectfully disagree with your disagreement. In this case, this "one size fits all" fits almost everybody that is invested in the stock market. VTSMX is 2/3'd S&P500 index fund and 1/3'd Russel 3000. The appropriate index is the Wilshire 5000 which has over 9000 stocks.

Over every 5 year rolling period, a VTSMX buy and hold investor will beat 80% of all managed money. Over every 10 year period, he'll beat 95% of all managed money. And over every 20 year rolling period, he'll beat 98% of all managed money. This "one size fits all" type of investment is pretty tough to beat.

The toughest decision of the VTSMX investor is how much cash to keep as a percentage of his portfolio. If the guy is a 60 year-old investor with a weak stomach, maybe he should keep more in cash than the 30 year-old investor who's shooting for an early retirement. The 30 year-old risk taker could use 20 to 30% margin and buy more VTSMX.

Personally, I'm not a VTSMX investor because I'm one of those RARE 2 out of 100 investors that actually has beaten VTSMX over the last 20 year period. My investment expenses are far less than the rockbottom 0.6% of assets that VTSMX would actually cost me. But as an extremely sophisticated long-time equity investor, I have no problem recommending VTSMX to any and all investors.
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jrr7,
There is a seperate Intermediate Bond Fund and an EAFE Fund, but it is odd that Russell 3000 is only offered as part of a blend fund.

We have a choice of 4 blend/balanced funds, each with different mixes of allocation: Aggressive, Moderate, Conservative, and Horizon. I believe whoever put the plan together created these funds to make it easy for someone who is new to investing, or doesn't want to do research, to pick something with some diversity.
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joebedford wrote:
I respectfully disagree. There is no "one size fits all" investing option. You do not know the original poster's age, or goals, or risk tolerance, or desire for "involvement" in their portfolio. To me, that means you do not know enough to make a valid recommendation. If you are invested solely in VTSMX then sure, say so and tell us why. But beware dispensing "investment panaceas". If the original poster was a 60-year-old, with a weak stomach, investing for retirement, then your advice would be horrible IMHO. :-)

galeno wrote:
I respectfully disagree with your disagreement. In this case, this "one size fits all" fits almost everybody that is invested in the stock market. VTSMX is 2/3'd S&P500 index fund and 1/3'd Russel 3000. The appropriate index is the Wilshire 5000 which has over 9000 stocks.

Over every 5 year rolling period, a VTSMX buy and hold investor will beat 80% of all managed money. Over every 10 year period, he'll beat 95% of all managed money. And over every 20 year rolling period, he'll beat 98% of all managed money. This "one size fits all" type of investment is pretty tough to beat.

The toughest decision of the VTSMX investor is how much cash to keep as a percentage of his portfolio. If the guy is a 60 year-old investor with a weak stomach, maybe he should keep more in cash than the 30 year-old investor who's shooting for an early retirement. The 30 year-old risk taker could use 20 to 30% margin and buy more VTSMX.

Personally, I'm not a VTSMX investor because I'm one of those RARE 2 out of 100 investors that actually has beaten VTSMX over the last 20 year period. My investment expenses are far less than the rockbottom 0.6% of assets that VTSMX would actually cost me. But as an extremely sophisticated long-time equity investor, I have no problem recommending VTSMX to any and all investors.


Galeno, I respectfully disagree with your disagreement with joe bedford. Joe's main point is that one size doesn't fit all, and that's absolutely correct.

Indeed, your assertion that a VTSMK investment almost always beats managed money, critically, is only true AFTER TAXES. Many managed funds beat the index on a PRE-TAX basis -- which is precisely what you get with 401(k)s and IRAs. I'm not saying at all that a total market index is inappropriate for the tax deferred accounts of many investors, but realize that you're losing the benefit of those accounts' tax deferral in the process, since the total market fund has such low turnover. Depending on your tax bracket, that may not at all be insignificant. And if you have substantial investments outside your tax deferred accounts, and choose not to have all of your investments in a total market index, then your tax deferred accounts are the absolute worst place to hold market index funds.

(P.S.: I keep my IRA in a REIT index fund, a high-yield bond fund, and two actively managed equity funds that have an extended record of beating the market on a pre-tax basis. My 401(k) is more concentrated in leveraged bond funds, active small cap funds and hedge/special situation funds that wouldn't be available to me (at such small levels) elsewhere. My taxable accounts are a diversified portfolio of equities and market index funds, and the total value of these accounts significantly exceeds that of my tax deferred accounts.)

I think your posting basically ignores the special tax treatment of tax deferred acccounts -- much as Tom Jacobs' article last week did. For a more extended reply, I copy here my earlier reply to Tom:

I wholeheartedly agree with Tom's central assertion that it's a bad idea to have conflicted plan providers offering advice to employees on 401(k) allocation decisions. Nevertheless, I think his article gives the impression that 401(k) plans are generally better served by being invested in index rather than actively managed funds. I do not generally agree.

Although Tom's contention that most actively managed funds do not usually beat the market index is correct, it is correct primarily for returns after transaction costs, which include both management fees AND -- often more crucially -- TAXES. In fact, many actively managed funds have long histories of beating the market indeces, even after management fees are subtracted, on a PRE-TAX BASIS.* But the central distinguishing principle for 401(k)s and IRAs is that you pay no taxes today on dividends or capital gains.

Thus, at least for taxpayers in higher tax brackets, 401(k)s and IRAs are the absolute worst place to hold index funds, because you lose a principal advantage of those funds, namely, that the lower turnover implicit in tracking an index gives a lower tax liability. (This assumes that these taxpayers hold index funds in their taxable accounts, probably a safe assumption for higher bracket taxpayers.)
Instead, 401(k)'s and IRAs are ideal for high yield bond funds, REIT funds, high-dividend stocks and certain actively managed equity funds. Indeed, you might argue that actively managed funds rationally exist primarily for the tax deferred accounts of higher bracket taxpayers, or for the taxable accounts of those taxpayers with low tax liability, much as tax exempt bonds exist primarily for the taxable accounts of higher bracket taxpayers.

I just think that it's important we not overbash actively managed funds in the context of tax deferred retirement accounts. Yes, it's very difficult for managers to beat the market on an after-tax basis; but lots of proven fund managers have beaten the market on a pre-tax basis, which makes actively managed funds a very attractive component of tax deferred accounts for investors without the time, inclination, or sophistication to choose individual securities.

*For example, Vanguard's Windsor Fund returned 14.4% over the 10 years through Dec. 2001, on a pre-tax basis, which beats the S&P's return of 12.94% over the same period; still, after all taxes (assuming the top marginal rates), its return was 10.77%, which loses to the S&P.
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Jim,
I think you are saying you want funds in your 401 or IRA that generate capital gains, since the tax on those gains is deferred until you are in a lower tax bracket.
Am I understanding you correctly?
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In this case, this "one size fits all" fits almost everybody that is invested in the stock market.

And on what basis did we decide that this investor was, or even should be, invested in the stock market at all?

The toughest decision of the VTSMX investor is how much cash to keep as a percentage of his portfolio.

Unless I misread the original poster, he seemed to be opining that you should not keep any cash in your portfolio. Put it all in an index, is what I recall he said.

Personally, I'm not a VTSMX investor because I'm one of those RARE 2 out of 100 investors that actually has beaten VTSMX over the last 20 year period.

Um, proving my point it's not for everyone? You are saying almost everyone. Again, a caveat I don't believe the original post included.

Thanks!
Joe
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JimCopland writes,

Many managed funds beat the index on a PRE-TAX basis --

How many is "many"?

Galeno's post stating that only about 5% of actively managed funds beat the S&P500 over a 20-year holding period matches the research I've seen. If you have any credible research that shows that a higher percentage of actively managed funds out perform, please post a link. I'd be interested in reading it.

intercst
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Intercst writes:

How many is "many"?

Galeno's post stating that only about 5% of actively managed funds beat the S&P500 over a 20-year holding period matches the research I've seen. If you have any credible research that shows that a higher percentage of actively managed funds out perform, please post a link. I'd be interested in reading it.


As would I. All the research I've seen shows the vast majority of managed funds underperform the index fund over 20 years on a pretax basis. In a tax deferred account, that would hold true on an after-tax basis as well. I've never seen any data to show otherwise. Sure, there are a very few managed funds that will do better than the index fund, but trying to pick those prospectively is far harder than trying to pick a winning stock. Indeed, until someone shows some research indicating otherwise, over the long haul an index fund is virtually a no brainer.

Regards..Pixy
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Jim,
I think you are saying you want funds in your 401 or IRA that generate capital gains, since the tax on those gains is deferred until you are in a lower tax bracket.
Am I understanding you correctly?


Centex,
Not exactly. My argument doesn't really turn too much on your tax bracket today vs. tomorrow (though it is a function of your age -- my argument applies most clearly to younger workers in the 20-40 range).

In general, it's always better to defer taxes until tomorrow rather than pay them today (assuming real interest rates are not negative), which is a basic "time value of money" concept that I'm sure must be explained elsewhere on the Motley Fool. More or less, it's that if you save that $100 this year (that you'd otherwise pay the government), you'll have $(100+r) next year, where r is your rate of return. So even if you have to pay the government the $100 next year, as well as pay the government tax on the return, you wind up with $(r - tr) extra dollars, where t is your tax rate.

The big advantage of tax deferred accounts like IRAs and 401(k)s is that you pay no current tax on either capital gains or current income (dividends or interest). (Lower income taxpayers can also take advantage of Roth IRAs, which let you avoid tax altogether rather than merely defer it; and taxpayers without 401(k)s can deduct current contributions to their traditional IRA.) Thus, if you're 30 today, you can hold an investment for the next 35 years paying no tax on either dividends paid or capital gains realized in the tax deferred accounts. (If you're near retirement age, the tax situation is more complicated, since you can be paying ordinary income tax rates tomorrow vs. capital gains, so be careful.)

This is a HUGE advantage, more the higher your tax bracket is. Consider: if you pay 50% of your income in taxes but get a 10% return, you only get 5% after tax; but if you don't pay that tax, you still get 10%. Over time, this advantage compounds and compounds: $100 today becomes $1,745 in 30 years with a 10% return, but only $432 with a 5% return. That's why tax deferred accounts are so powerful. But broad market index funds lose a good bit of this tax value, since the market's dividend payout ratio is low, and these funds have low turnover since they merely track an index.

Thus, assuming you hold some sizable investments outside your 401(k) and IRA, it's advantageous to focus tax deferred accounts on high tax holdings (i.e., those that realize high current income through high dividend/interest payouts and/or turnover-related capital gains), while focusing taxable accounts on low tax holdings (i.e., those that realize low current income by paying little or no dividends/interest and having lower turnover). Of course, because capital gains are tax deferred already (only paid when realized), and taxed at lower rates, the tax advantage is most significant for funds that pay out high current earnings in dividends or interest.

Also, note that one advantage to investing your IRA (and 401(k)) in multiple, diversified funds over time is that you get to rebalance your portfolio tax-free whenever you want -- something you can't do in taxable accounts. Theory and empirical evidence suggest that some diversification with regular, transaction-cost-free rebalancing can beat an all-U.S.-equities portfolio return. The theory and empirics are too complicated to go into here, but I don't think most investors will hurt themselves by keeping a limited portion of their portfolios in commodities, bonds, and real estate and regularly rebalancing -- and because 401(k)s/IRAs let you do that for free, they're the perfect vehicle for it.

Now, this argument isn't in any way meant to slam index funds. I think that most investors are best served primarily by investing in the market index. If all you're saving is your retirement account, invest that primarily in an index fund. And a lot of investors may prefer to put all their savings in index funds, due to a lack of sophistication; this strategy can work fine -- they'll make out well in the long run. But a lot of actively managed funds do in fact beat index funds on a pre-tax basis, and have relatively low management fees,* so you may well wish to consider active funds for the tax deferred portions of your portfolio. The broader point is that if you hold a mix of actively managed and index funds, you should (generally) concentrate the actively managed funds in the tax-free account, the index funds in the taxable account.

*A couple of examples from Vanguard, with 10-year track records: Windsor (0.36% management expense, 14.4% pre-tax return vs. 12.94% S&P 500 & 14.16% Russell 1000 Value Index), Explorer (0.64% management expense, 12.97% pre-tax return vs. 7.19% Russell 2000 Growth Index).

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In general, it's always better to defer taxes until tomorrow rather than pay them today (assuming real interest rates are not negative),

Also assuming:
- you will still have the money tomorrow (if you're at risk of being robbed, or of squandering the money, you might want to pay the taxes today)
- that tax rates stay the same (if tax rates are going up, or you cross into a higher bracket, the extra interest you earn might not be worth it)
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In general, it's always better to defer taxes until tomorrow rather than pay them today (assuming real interest rates are not negative),

Also assuming:
- you will still have the money tomorrow (if you're at risk of being robbed, or of squandering the money, you might want to pay the taxes today)
- that tax rates stay the same (if tax rates are going up, or you cross into a higher bracket, the extra interest you earn might not be worth it)


good point -- especially #2, which isn't always transparent
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Intercst writes:

How many is "many"?

Galeno's post stating that only about 5% of actively managed funds beat the S&P500 over a 20-year holding period matches the research I've seen. If you have any credible research that shows that a higher percentage of actively managed funds out perform, please post a link. I'd be interested in reading it.

As would I. All the research I've seen shows the vast majority of managed funds underperform the index fund over 20 years on a pretax basis. In a tax deferred account, that would hold true on an after-tax basis as well. I've never seen any data to show otherwise. Sure, there are a very few managed funds that will do better than the index fund, but trying to pick those prospectively is far harder than trying to pick a winning stock. Indeed, until someone shows some research indicating otherwise, over the long haul an index fund is virtually a no brainer.

Regards..Pixy


I think Galeno's actual claim was that only 2% of actively managed funds beat the market index over 20 years, 5% over 10 years. I see these kind of claims thrown around a lot on here, so before giving my long-winded reply I'll throw back your request -- any actual citation to legitimate empirical research that buttresses this claim would be most welcomed.

The empirical research as I understand it suggests that the average mutual fund manager slightly underperforms the S&P 500. The seminal research on this was from Michael Jensen. See, e.g., "The Performance of Mutual Funds in the Period 1945-64", 1968, J of Finance; and "Risk, the Pricing of Capital Assets, and the Evaluation of Investment Portfolios", 1969, J of Business. Similar, more recent studies have reached similar conclusions.

These studies tend to support the semi-strong form of the efficient market hypothesis -- i.e., that available public information is perfectly and immediately impounded into market prices. Under this theory, it is essentially impossible to "beat" the market in the very long run, on a risk-adjusted basis, without private information. This doesn't mean that in a random sample of active managers over some time period, you won't have some managers beating the market. In fact you'd expect some managers to beat the market based on random chance. Indeed, if you ignored (a) transaction costs, and (b) survivorship bias in the market index, you'd expect rational managers acting in their funds' best interest to be more or less normally distributed around the market on a risk-adjusted basis – i.e., 50% of them beating the market. Of course, managers' interests aren't at all perfectly aligned with fundholders'; in reality, I think you'd expect the median manager to be below the market mean, with skewness to the upside, as managers took greater risks (with other people's money).

So, in the long run, if semi-strong efficiency perfectly holds and active funds have higher transaction costs than passive funds, it obviously makes no sense to put your money in active funds. But, there is some pretty good evidence that semi-strong efficiency doesn't perfectly hold, e.g.: small firm effects (studies showing small firms outperform large firms on a risk-adjusted basis, see, e.g., Banz, “The Relationship between Return and Market Value of Common Stocks,” 1981, J Financial Economics), the related January effect and other temporal anomalies (see, e.g., Keim, “Size Related Anomalies and Stock Return Seasonality: Further Empirical Evidence,” 1983, J. Financial Economics; Reinganum, “The Anomalous Stock Market Behavior of Small Firms in January: Empirical Tests for Tax-Loss Effects,” 1983, J. Financial Economics; French, “Stock Returns and the Weekend Effect,” 1980, J. Financial Economics), neglected firm effects (see, e.g., Arbel and Strebel, “Pay Attention to Neglected Firms,” 1983, J. Portfolio Management), market-to-book ratio effects (see., e.g., Fama and French, “The Cross Section of Expected Stock Returns,” 1992, J. Finance), and overreaction or “reversal” effects (see, e.g., Lehmann, “Fads, Martingales and Market Efficiency,” 1990, Q. J. of Economics).

Now, there may be more recent studies disputing some of these findings and more conclusively establishing semi-strong market efficiency; I don't know – if so, please share them. And these studies don't in any way overturn the semi-strong efficient market hypothesis in general; indeed, I think the hypothesis should serve as the default legal rule in judicial decision-making, and I do believe that passive index funds should be the default for most normal investors. I myself have a lot more money in passive funds than active funds.

BUT… I do think that the empirical evidence out there does suggest that it is possible to improve returns above the market, on a risk-adjusted basis, employing some contrarian strategies, especially focused on small or neglected firms. And my own observations – admittedly casual and anecdotal, not statistically significant – lead me to believe that it's possible to beat the market on a risk-adjusted basis without inside information. I know a lot of people in the hedge fund industry who work in equity funds that offset long and short positions and make pretty consistent positive returns. If you assumed that semi-strong efficiency perfectly held and they had no inside information, the expected return would be 0, since longs and shorts would offset in a zero-sum game. Now, maybe these folks are just lucky. These funds do blow up sometimes – though for equity hedge funds that's usually because one bad year puts them below a high-water mark that reduces profitability and gives the managers an incentive to return capital; and the long-run fundholders will still get some positive return (e.g., Tiger Management). Realize that sophisticated, wealthy investors pay ridiculously high fees to buy into these funds. That's not to say they're all smart and certainly not to say they should expect to beat the market return – to the contrary, they may pay for lower expected returns, given that those returns are essentially uncorrelated to their larger market holdings. But if semi-strong efficiency held, these investors would be complete idiots, since the expected return of a hedge fund that balanced longs and shorts would be 0, and they'd have a negative expected return after fees.

I remember a conversation I had with a large, successful fund manager about how he made a killing shorting a shoe/clothing company marketed to urban inner city kids, after one of the guys working at his fund had talked to urban inner city kids he volunteered with and discovered that these shoes/clothes were “last year's thing.” This information was public, but not yet assimilated into the stock price, so the fund made a lot of gains shorting the stock, which soon dropped when the next quarterly report showed a steep revenue decline.

One of my best friends runs a company that matches a network of experts to hedge fund and mutual fund managers. These funds pay a lot of money for these people's information. It's not “inside” information, but it is, like the example above, “quasi-private” in the sense that it's not necessarily impounded into the market price.

All of which is a longwinded way of saying that I don't think that semi-strong market efficiency holds to the degree that it makes sense to reject the idea of actively managed mutual funds out of hand. Indeed, Pixy you suggest as much saying it's easier to pick stocks than fund managers (a VERY questionable assertion if you accept semi-strong market efficiency; if semi-strong efficiency holds, and you lack inside information, I don't see how you beat the market in the very long run on a true risk-adjusted basis), as did galeno in saying he's “one of the 2%” who has beaten the market over the years.

What IS certain is that the higher the management fees of the fund, all else being equal, the lower the chance that an actively managed fund can beat the index. The reason that so many active funds lose out to passive indexes is precisely that so many active funds have high management fees. That's the contention of Vanguard's Jack Bogle, anyway, who argues for indexing precisely on the ground of lower fees, not semi-strong efficient markets. See http://news.morningstar.com/doc/article/0,1,5766,00.html.
The thing is, not all actively managed funds are alike. They don't all have the same fee structure. If you do a sort of funds on Morningstar and take out all the actively managed funds above a certain fee threshold, then suddenly performance vs. the passive index changes (indeed, as you'd expect under semi-strong market efficiency before transaction costs). Vanguard itself has plenty of low cost managed funds; often the operating expenses are only 0.1-0.2% higher than those at the comparable Vanguard passive index fund. That's not so much, even over the long run: in 20 years, if the expected annual market index return is 11%, you get an 806% expected return, vs. 792% with an additional 0.1% fee vs. 778% with an additional 0.2% fee. That's a far cry from say an additional 2% management fee, which would lower your expected return to 560%.

The real question is whether those extra fees can enable a manager to beat the market by buying quasi-private information or analysis, as discussed above. For those active funds with additional fees in the 0.1-0.2% range, I'm willing to bet they might, at least on a pre-tax basis, at least for small cap and international holdings. (Notice I said might, not will -- I still have more money in passive index funds, and I'd advise most investors to do likewise.) For those with much higher management fees, my general bet would be no way (at least, unless what I'm buying is something that isn't really intended to beat the market but rather give a positive return uncorrelated to the market, thereby enabling me to get a higher risk-adjusted return for my total portfolio, and/or get returns not publicly available (e.g., private equity, venture capital)).

If you agree with me that active fund managers can beat the market, assuming your extra fees buy more value than you pay, then the real question remains whether it's possible to identify them with any confidence. The short answer is, I don't know for sure. There are empirical studies that show persistence of performance by mutual fund managers (e.g., Hendricks, Patel, and Zeckhouser, “Hot Hands in Mutual Funds: The Persistence of Performance,” 1991), but it's hard to have confidence in these results given inherent survivorship bias problems (see Brown, Goetzmann, Ibbotson and Ross, “Survivorship Bias in Performance Studies,” 1992). I tend to go with established funds with established managers with established records, and let the chips fall. I use these active funds to diversify my overall portfolio, stick to low fee options, concentrate them in areas where the empirical evidence against semi-strong market efficiency is highest (e.g., small cap and international), and put them in my tax deferred accounts, which was my original, central point – since active funds tend to generate more tax liability, if you hold them, they should be in your tax deferred account.

I know this is long and rambling, but I hope it's useful to somebody, and I welcome comments. I have additional thoughts on what you wrote, but since this is so long already I'll save them for a different post.
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So, back to the original question:
Does the allocation they recommend pass muster for someone 20 years from retirement, or does it totally suck, or what? :-)
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I'd like to recommend the following website:

http://www.investorhome.com/anomaly.htm

Looks at all the purported anomalies critically but not dismissively.
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Centex wrote:

So, back to the original question:
Does the allocation they recommend pass muster for someone 20 years from retirement, or does it totally suck, or what? :-)


Well, the answer to your question depends on what else you hold in your portfolio. But the short answer is that I think the allocation "passes muster" for you if it's a stand-alone investment, especially in light of the fact that you already hold a small cap IRA. If you do have any other investments, though, you'll want to think about how your 401(k) allocation fits into your total portfolio.

Looking at your recommended allocation, the first thing I did notice is that there's a lot of overlap among the funds. Many of them explicitly hold the same indexes, albeit in different percentages. That's not an inherent problem as long as (a) you're aware of it, and the implications, and (b) you don't get stuck with any additional fees, such as those Vanguard levies on smaller accounts (see the recent "Roth IRA" postings on this board). If you DO get stuck with extra fees for small amounts in the funds, you'd be better off consolidating, since they overlap already.

Let's look at what they're recommending, once you disaggregate/reaggregate each fund:

25% S&P 500
25% Russell 1000 Value
22% Russell 3000
16% EAFE
8% Bond
5% Interest

That's 72% U.S. equities, which makes total sense when you've got a 20-year time horizon. Notice, though, that you're definitely weighted toward large caps. The S&P is large caps, so is the Russell 1000 (with a very high correlation to the S&P, though it's a bit broader index), and I think about 90% of the Russell 3000 market cap is the Russell 1000. So only ~2% of this portfolio is in small caps. That doesn't trouble me too much for you if your IRA is small cap-oriented, but depending on the dollar amounts it's a possible concern.

I do like that you've got some tilting toward "value" holdings by using the Russell 1000 value index. "Value" stocks will tend to have higher dividend yields, and thus, you'll take more advantage of the 401(k)'s tax exemption on dividends (particularly important if you have other outside investments and are in a higher tax bracket).

I also like that they've got you with some international exposure. Too many American investors, I think, invest in only U.S. equities when both theory and empirics suggest you can get a higher risk-adjusted return with some portion of your portfolio invested internationally. However, though I'm not an international tax lawyer or accountant, I'm pretty sure you lose some of the 401(k)'s tax benefits by holding international funds, because you pay overseas tax and don't get to claim a foreign tax credit to the IRS. Though this won't make much of a difference now, over the long run it can matter; therefore, in a few years, you may wish to begin accumulating some international funds in your taxable accounts and shift away from them (tax free) in your non-taxable accounts. Also, realize that the EAFE index essentially gets you Western Europe and Japan; if you want some emerging markets exposure (for a small percentage of your portfolio), you'll need to get it elsewhere.

As a general principle, I you should focus on 3 main principles in your 401(k) decisions:

1. Your overall portfolio composition and goals -- Unless your 401(k) is all you're saving for retirement, you'll want to fit it into your overall portfolio scheme. Thus, especially in the early years, you might focus principally on diversification away from other holdings if you're overconcentrated outside your 401(k). In addition, over time, 401(k)s can be ideal vehicles for portfolio rebalancing, since you can do it tax free (just make sure you don't get stung by fees from the funds you're holding).

2. The outside availability of 401(k) options -- If you have the opportunity to get into investments you can't buy on your own (e.g., hedge funds, private equity investments, various leveraged bond or equity funds), you may wish to focus there, assuming you have outside holdings and/or the capacity for substantial investment outside the 401(k).

3. Tax considerations -- As I've stressed elsewhere in this chain of replies, if you have holdings outside your 401(k) and IRA, it's advantageous to focus the tax deferred accounts on high tax holdings (i.e., those that realize high current income through high dividend/interest payouts and/or turnover-related capital gains), while focusing taxable accounts on low tax holdings (i.e., those that realize low current income by paying little or no dividends/interest and having lower turnover). In beginning years, this principle isn't crucial; but over time if you forget it you're throwing away a lot of money (or contributing it to the government, depending on your political philosophy). E.g., you might put higher dividend "value" equity holdings in your 401(k) and lower dividend "growth" holdings in your taxable accounts (assuming that your regular income tax rate is substantially higher than the long-run capital gains rate; if you're a lower bracket taxpayer this wouldn't apply).

Anyway, in sum, I think the recommendation they gave you is pretty sensible, depending on what else (if anything) you hold. And remember -- as long as you're avoiding fees and making broad, diversified market investments you'll likely be fine. They key is maxing out your 401(k) and IRA contributions and saving as much as possible on top of it -- if you do that you're way ahead of most Americans.

Jim
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