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I posted this question elsewhere but I think it belongs here.

My husband and I are both maxed out in our 401K's in S&P funds (current balance me 36K him 9K). We want to open a Roth IRA and aren't sure if we should invest in small caps, European index, or technology. I've been researching for months and just get more confused as to what's the wisest next step.

Any advice or tips would be great.

Thanks,

Mia

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*My husband and I are both maxed out in our 401K's in S&P funds (current balance me 36K him 9K). We want to open a Roth IRA and aren't sure if we should invest in small caps, European index, or technology. I've been researching for months and just get more confused as to what's the wisest next step.*

*****

Mia,

You don't mention what your 401k is invested in. I'll assume that your 401k is like most, and that if offers limited choices.

You might consider putting your IRA money into a Dow Dividend strategy (like the RP4/F4). Here is a good place to learn more:

http://www.fool.com/school/dowinvesting/dowinvesting.htm

Fool on!

messerb

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As I am sure you have found out, small caps are currently out-of-favor, and the Wise keep saying its time for their day in the sun, although they really can't tell you when, just that it *ought to* happen. The Wise are now saying that it's time to get back in certain emerging markets, but you gotta know which one. They also say it's time for Europe to have its own blue-chip rally because of the euro. And, as you probably know, technology can be very volatile. Yeah, it's easy to be confused.

Why do you want to diversify? Do you want to try to get a better return than the S&P funds you are invested in, or do you want to invest in different market sectors to reduce volatility, as Modern Portfolio Theory dictates?

If you want to reduce the 'risk', ie. volatility, of your portfolio, I say, don't bother. Since your retirement money is invested for the long-term (based on your balances, another 25-30 years), your 'risk' is automatically reduced by your time horizon. Your money will grow according to the S&P return, in the long-term, and the fluctuations will matter less, as time goes on. Volatility is something you *may* want to consider a few years before retirement, but not until then.

If you want a better return for your money, look into the various portfolios, www.fool.com/portfolios, that TMF sponsor, or look into the investment workshop, www.fool.com/workshop, for investment ideas and investment screens.

Zev

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Zev wrote *If you want to reduce the 'risk', ie. volatility, of your portfolio, I say, don't bother. Since your retirement money is invested for the long-term (based on your balances, another 25-30 years), your 'risk' is automatically reduced by your time horizon. Your money will grow according to the S&P return, in the long-term, and the fluctuations will matter less, as time goes on. Volatility is something you may want to consider a few years before retirement, but not until then.*

I believe that volatility is ignored too frequently in analyzing returns.

For example, compare two investors each with 100k invested.

First investor is in a volatile fund that returns 50% the first two years and then loses 50% the third year. So, after first year 100k becomes 150k; after second year 150k becomes 225k; after thrid year 225k becomes 112.5k. The mean return for the three years is 16.67% -- (50% + 50% + -50%)/3 = 50%/3 = 16.67%. How deceiving, because the compounded rate of return is actually more like 4% (NOTE ballpark guess because I do not have the time to calculate now and my easy to use software is on the other computer).

Second investor is in a more conservative index and gets returns of 10%, 10% and 1%. After the first year 100k becomes 110k; after the second year 110k becomes 121k; after the third year 121 k becomes 122.2k. The mean return for the three years is 7% -- (10% + 10% + 1%)/3 = 21%/3 = 7%.

BUT WHO HAS MORE MONEY AFTER THREE YEARS? Obviously, I constructed this example to illustrate a point and it does confirm Mark Twain's comment that "there are liars, there are d@mn liars, and then there are statistics."

As we all acknowledge around here, one cannot predict the market exactly, which is why market timing is generally ignored at the Fool, but I believe that ignoring portfolio allocation completely is also *foolish*. See for example, intercst's recent post in the Managing your Portfolio Board - something like post 1629.

Just my $0.02. YMMV. Regards, JAFO

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JAFO31's point in #11109 is well taken, but his assumption in calculating the gains and losses as a percent is incorrect. This is because, if you calculate gains and losses in percent, you must multiply them, not add them.

The correct annual equivalent returns in JAFO31's two examples are 4.000% and 6.911%, to 3 decimal places.

This topic is discussed in a couple of threads on the Math board. Just enter Math in the "Board" box at the bottom of your screen. Then hit Find.

To simplify the ideas, suppose you start with $10,000 and the first year you make 50%. So you have $15,000. The next year you lose 50%. So you have $7500. So, you have lost 25%. What is your equivalent annual return? It is that (negative) rate that, when compounded, would cause you to be down to 75% of what you started with after 2 years. The answer is about 13.397% per year. Twice 13.397 is more than 25, but it all works out because you are starting out from a smaller (equivalent) base at the beginning of the second year.

A minor point, but there are things JABoa the Pedant can't let slide past.

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In response to my earlier post, JABoa wrote, in part, *" This is because, if you calculate gains and losses in percent, you must multiply them, not add them.*

The correct annual equivalent returns in JAFO31's two examples are 4.000% and 6.911%, to 3 decimal places.

Glad to know the methodology and the exact numbers [presumably on a annual compound basis? (:>)] from someone far more skilled in mathematics than I. As I admitted in my first post I can be a little lost without all my software.

<<The mean return for the three years is 16.67% -- (50% + 50% + -50%)/3 = 50%/3 = 16.67%. How deceiving, **because the compounded rate of return is actually more like 4% ** [emphasis added in this post] *(NOTE ballpark guess because I do not have the time to calculate now and my easy to use software is on the other computer).* [additional emphasis added in this post]

. . . The mean return for the three years is 7% -- (10% + 10% + 1%)/3 = 21%/3 = 7%.>>

I thought that I was acknowledging that actual compounded rate of return was significantly different than apparent mean average for the three years, but I guess I was not clear.

JABoa also wrote *A minor point, but there are things JABoa the Pedant can't let slide past.*

I was trying to illustrate the difference between the real compound rate of return versus the apparent mean average with volatile investments to show why volatility should not be completely ignored. I was not trying to slide anything past anybody.

With JABoa's able assistance we know that the volatile investment from my example -- +50%, +50%, -50% has a 4.000% return over three years, which is very different from the apparent mean average of 16.67%. We also know that the more conservative investment from my example -- +10%, +10%, +1% has a 6.911% return over three years, which is not very different from the apparent mean average of 7%, and would have been the better returning investment over that three yeqr period. JABoa has illustrated the point I wanted to make more clearly than I did! Thanks,

Regards, JAFO

<<The mean return for the three years is 16.67% -- (50% + 50% + -50%)/3 = 50%/3 = 16.67%. How deceiving, **because the compounded rate of return is actually more like 4% ** [emphasis added in this post] (NOTE ballpark guess because I do not have the time to calculate now and my easy to use software is on the other computer).

. . . The mean return for the three years is 7% -- (10% + 10% + 1%)/3 = 21%/3 = 7%.>>

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I hope JAFO31 did not think I was taking him to task, because I was not intending to. As a matter of fact, I am grateful to JAFO31 for not chastising me when I spout off on matters that I obviously know nothing about.

However, correct conclusions incorrectly arrived at have to be examined, and that was my point. JAFO31, I have been a mathematics instructor for half my professional career. You get half marks, that is all. Sorry. I hope we can be cyber-friends. Actually, I hope we already are cyber-friends.

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JABoa wrote *"I hope JAFO31 did not think I was taking him to task, because I was not intending to. As a matter of fact, I am grateful to JAFO31 for not chastising me when I spout off on matters that I obviously know nothing about.*

However, correct conclusions incorrectly arrived at have to be examined, and that was my point. JAFO31, I have been a mathematics instructor for half my professional career. You get half marks, that is all. Sorry. I hope we can be cyber-friends. Actually, I hope we already are cyber-friends."

JABoa, I did not think that you were taking me to task and we are already cyber-friends.

I guess I was still not explicit enough - I always understood that 100k returning +50%, +50%, -50% for three years for a total account of $112,500 meant that you had made a grand total of 12,500 over three years which by eyeball estimate seemed about equivalent to investing 100k and making approximately 4% per year, AND SO STATED THE APPROXIMATE 4% return in my original post; I simply did not offer a full explanation to try and keep the post from getting too long. The error of omission is mine, but I did not have an error of understanding.

What I could not do easily, was the exact calculation of the exact return. I have software on my home computer that will calculate the annual rate of return giving a starting amount, ending amount and term, but I cannot access it from my office.

If I were so inclined, I could construct a spreadsheet and use a little trial and error and get a more exact calculation. I did not take the time when I first posted, but since then I have and we disagree slightly --- I calculated the return as 4.00419% when compounding occurs annually and at the end of the year, which is slightly higher than your three decimal point number of 4.000% but I am still inclined to trust your calculation more than mine.

What I cannot do is recite the formula and then solve the equations. I have seen far too many of your posts to truly challenge you over the calculations and math in general.

I do, however, think it is counter-intuitive for most people to believe that a 100k investment returning +50%, +50%, -50% for three years would be worth only $112,500 (and the equivalent of a 4% annual return) and that it would be less than an investment returning +10%, +10%, +1% for the same three year period, which would be worth approximately $122,200 (and would have returned the equivalent of 6.9+% annual return).

To repeat myself, again, I was trying to illustrate why ignoring volatility altogether may not be a good choice for a portfolio instead of actually calculating whether the return in the first example was 4.000% or 4.00419% and the second example was 7% or 6.9xx%. Regardless of the exact numbers, the second example has had a better return over the same three year period.

JABoa, I guess the real point of this lengthy post is I do not want you to think me mathematically illiterate, even though I acknowledge that I am no great mathematician.

Regards, JAFO

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Woah! I didn't intend to spark the mathematical-like debate. Thank you all for lots of detail however. Appreciate it.

Mia

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Since you stated that your 401k money is in S&P funds, I'd consider that the same as having money in the RP4. Might think about using a growth oriented screen such as Keystone or Spark to add some diversity. That's how I handle my similar situation.

JLC

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*BUT WHO HAS MORE MONEY AFTER THREE YEARS?*

Unfortunately, you missed my point. I am concentrating on overall long-term return. (Besides, I already own the fund that the first investor is in). While it is certainly more desirable to get an average 10% return with less year-to-year fluctuation, if you believe that you will get the 10% return, in the long-term, ignore the fluctuations.

The problem with Modern Portfolio Theory, with respect to diversification, is that it says that if you have investments with volatile returns that don't correlate to each other, your *overall* portfolio risk is reduced. That is great, mathematically, but imagine how an investor feels, watching one investment zig 50%, while the other one zags -40%, and then they reverse.

Zev