Taxes Have a Role in Asset Allocation

"The key thing is to have a diversified portfolio," says Armstrong. "Every portfolio should have some combination of stocks and bonds. The days of being a cowboy with 100% equity are gone."

Even if his clients are young with 40 years to go before retirement, Armstrong has them put at least 20% in bonds and cash, with 80% in equities.

He notes that by law, every 401(k) plan must have at least one equity fund, one bond fund and one stable-value or money-market fund. In a rising interest market, as we're experiencing today, stable-value funds can offer better returns than bond funds, he says.

For those who have taken maximum advantage of their workplace retirement plans and can afford to invest in taxable accounts, Armstrong recommends investing in exchange-traded funds, or ETFs. These are securities similar to index mutual funds but cost less to acquire and trade like stocks. (Click here to learn more about the ABCs of ETFs.)

Armstrong favors iShares S&P500 Growth Fund (IVW Quote), which tracks the S&P 500, and the iShares Dow Jones Select Dividend Index Fund (DVY Quote).

Christopher P. Van Slyke, CFP, with Capital Financial Advisors in La Jolla, Calif., adheres to the bonds-for-retirement-accounts view as well, but says it can't always be accomplished.

He has one client, the owner of a small business with several employees, who has $1.4 million in a defined benefit retirement plan for himself and the employees. While it would be best for the client to keep bonds in the pension account and invest in stocks outside the account, he would be violating his fiduciary duty to his workers if he didn't diversify the pension with stocks.

"We had to give up some of the tax benefit," Van Slyke says. "Taxes aren't the only consideration."