Help! My Portfolio Needs an Overhaul!

Dear Dr. Don,

I enjoy reading your articles on TheStreet.com and could use some advice. I'm 38, married with two kids, ages seven and three. I provide the sole income ($72K) for our family. I'm in the midst of trying to get my portfolio diversified and need some help.

I realize I'm sitting on a lot of cash. That cash position is largely due to an IRA rollover that I didn't know what to do with. My primary concerns are investing for retirement at 62, and being able to have a $50,000 annual income in today's dollars. I max out on my 401(k). Additionally, I make the maximum allowable contributions to Roth IRA accounts for my wife and I.

I don't have much time to research stocks anymore and would like to put my cash to work in some good mutual funds. I'm trying to take an overall look at everything I have to make this decision, as it would provide me with a more diversified portfolio. I think my current mix is 44% large company, 4% small company and 52% cash. A financial planner recommended: 35% large company, 20% small company, 25% international, 15% bonds and 5% cash. I'm not sure about putting so much toward international -- 15% to 20% would be more like it. Also, I know bonds would add to a more balanced portfolio, but am not sure if I need to even be in them at my age.

I also contribute to my kids' education by funding Educational IRAs and plan to start funding Section 529 plans next year, although I'm not as worried about paying for college as I am about retiring.

Thanks,

SC

SC's Portfolio
SC's 401(k) Account
Name	Shares	Market Price	Market Value	% Total Value	YTD Return	Morningstar's Stock Industry or Fund Category
(FEQIX)Fidelity Equity-Income II	41.18	19.01	783	0.35%	-16.63%	Large Value
(FDGRX)Fidelity Growth Company	16.54	42.75	707	0.32	-40.01	Large Growth
(FMAGX)Fidelity Magellan	8.49	90.54	769	0.34	-23.48	Large Blend
(FUSX)Fidelity Spartan U.S. Equity Index	21.63	35.52	768	0.34	-23.40	Large Blend
Cash	1,038.00	1.00	1,038	0.46	n/a	Money Market Funds
Account totals:			$ 4,065	1.82%
SC's Roth IRA Account
Name	Shares	Market Price	Market Value	% Total Value	YTD Return	Morningstar's Stock Industry or Fund Category
AOL Time Warner(AOL)	100.00	32.50	3,250	1.45	-6.61	Online Information
Boeing(BA)	103.62	32.80	3,399	1.52	-49.87	Aerospace
Ericsson Telephone ADR B(ERICY)	200.00	3.71	742	0.33	-66.54	Cable/Wireless Equipment
General Electric(GE)	110.89	35.20	3,903	1.74	-26.07	Electric Equipment
Home Depot(HD)	151.10	36.01	5,441	2.43	-20.98	Home Supply Stores
Lowe's Companies(LOW)	200.93	29.44	5,915	2.64	32.56	Home Supply Stores
Cash	35,408.00	1.00	35,408	15.82	n/a	Money Market Funds
Account totals:			58,059	25.93%
SC's IRA Rollover Account
Name	Shares	Market Price	Market Value	%Total Value	YTD Return	Morningstar's Stock Industry or Fund Category
Atmel(ATML)	1,000.00	6.26	6,260	2.80	-46.15	Semiconductors
Intel(INTC)	100.00	21.31	2,131	0.95	-29.25	Semiconductors
(VFINX)Vanguard 500 Index	198.00	92.55	18,325	8.19	-23.38	Large Blend
Cash	88,500.00	1.00	88,500	39.53	n/a	Money Market Funds
Account totals:			115,216	51.46%
SC's Wife's Roth IRA Account
Name	Shares	Market Price	Market Value	%Total Value	YTD Return	Morningstar's Stock Industry or Fund Category
(VASGX)Vanguard LifeStrategy Growth	1,021.58	15.62	15,957	7.13	-19.29	Large Blend
Account totals:			15,957	7.13%
SC's Taxable Account
Name	Shares	Market Price	Market Value	Total Value	YTD Return	Morningstar's Stock Industry or Fund Category
Cisco Systems(CSCO)	600.00	12.56	7,536	3.37	-67.16	Phone/Network Equipment
(DREQX)Dreyfus Growth Opportunity	1,118.00	6.99	7,815	3.49	-23.87	Large Blend
(VASGX)Vanguard LifeStrategy Growth	975.00	15.62	15,230	6.80	-19.29	Large Blend
Account totals:			30,580	13.66%
Portfolio total:			223,877	100%

Dear SC,

A lot of TSC readers would like to be in your shoes right now, riding out the recent market selloff with 57% of their portfolios in cash investments. Keeping that money in cash isn't the answer when planning how to invest your portfolio to meet your financial goals, though, but you're right to proceed cautiously.

I'm curious to know how you came up with your target of an inflation-adjusted $50,000/year income need in retirement. It would be a shame to meet that goal only to discover that it didn't meet your actual need for income in retirement. If you used your gut to determine the number, use your noggin and TSC's retirement calculators to confirm that it's a good number. Remember to figure out what part of that income you can expect to be satisfied by Social Security and any pension benefits, and what part will need to come from your investment portfolio.

I used Morningstar's Portfolio Manager to determine the overall composition of your portfolio, and to break down the stock investments by their market capitalization and growth-vs.-value orientation. The tables below show the results:

SC's Asset Allocation
Cash	57%
U.S. Stocks	39%
Foreign Stocks	3%
Bonds	2%
	100%
SC's Equity Allocation
Large Cap Growth	51%
Large Cap Value	34%
Mid/Small Cap Value	3%
Mid/Small Cap Growth	12%
	100%
Source: Morningstar's Portfolio Manager

There's obviously room to add mid-cap and small-cap exposure to your stock investments, as well as some foreign stock investments and bonds.

As far as foreign stocks go, your international exposure shouldn't exceed 20% without a specific reason for that level of exposure, like you're planning on retiring in Madrid. A more reasonable level would be 8%-15%. As I've said before in this column, one foreign stock fund you should consider is the (TBGVX)Tweedy Browne Global Value Fund, in part because the fund hedges its currency risk, which reduces its volatility.

Regarding your other funds, the (DREQX)Dreyfus Growth Opportunity fund has a new management team and a redefined investment objective, and it hasn't been very tax-efficient over the past few years. This makes it a poor choice for holding in a taxable account. I'd like to see your taxable account invested in tax-efficient mutual funds, and long-term stock positions or exchange-traded funds (ETFs) like Vanguard's Vipers, iShares or other ETF offerings. Let the tax-deferred and tax-advantaged accounts hold the less tax-efficient investments.

The (VASGX)Vanguard LifeStrategy Growth fund takes a fund-of-funds approach to asset-allocation decisions. It invests in the (VAAPX)Vanguard Asset Allocation fund (25%), the (VBTIX)Vanguard Total Bond Market Index (10%), the (VITSX)Vanguard Total Stock Market Index (50%) and the (VGTSX)Vanguard Total International Stock Index (15%), which is also a fund of funds. The only tax-efficient fund of the four named is the Total Stock Market Index, but because of its large weighting, the LifeStrategy Growth fund's overall tax efficiency isn't too bad. The Vanguard Asset Allocation fund is the gunslinger in this group of funds. The fund manager chooses between investing in the S&P 500 index and U.S. Treasury bonds based on projected market trends.

You've said that you don't have the time to research stocks and you're looking for a group of funds that will manage the investment selection for you. You need to decide whether you're more comfortable with the majority of your mutual fund investments being index funds, as they currently are, or whether you want to have a smaller base of indexed funds and look more to mutual fund managers who follow active investment strategies. Which way you lean on this topic will influence your approach in adding mid- and small-cap exposure to your portfolio.

For the fixed-income component of your retirement portfolio, consider inflation-indexed bonds. The U.S. Treasury Inflation- Indexed notes and bonds give you a hedge against inflation. They're best when held in tax-deferred or tax-advantaged accounts. Series I Savings Bonds are another method of investing in inflation adjusted-securities and provide more flexibility than TII's with respect to when you must recognize the income on the investment.

Finally, you don't have to wait to fund the Section 529 plans for your children. The new tax bill will allow them to withdraw money for qualified educational expenses free of federal taxation starting next year -- and in many cases free of state income taxes, too -- but you can start funding those plans today. You just can't fund both an Education IRA and a Section 529 Plan in the 2001 tax year (this IRS link explains why). In some states, contributions generate a state income tax deduction. Savingforcollege.com has a Section 529 Evaluator that allows you to compare your state's plan against plans in other states. Remember that education IRA contribution limits also increase to a maximum of $2,000 in the 2002 tax year.

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