Quitting the Large-Cap Growth Habit

Dr. Don,

A recent self-evaluation of my retirement portfolio indicates that I'm way too inclined to invest in large-cap growth stocks and funds. I've been rebalancing to some extent and need additional advice on how to finish the task.

Both my wife and I are 37 years of age and we have two children (ages 8 & 5). Our annual combined gross income is approximately $115,000, and we have monthly mortgage & car payments totaling $1,600. I contribute the maximum to my company 401(k) (which matches 100% on the first 6%) and to a Roth IRA. My wife contributes only to the Roth. We have opened Uniform Transfers to Minors Act (UTMA) accounts for both children and contribute about $1,000 annually to those accounts. I have an above-average risk tolerance and a desire to retire at age 62.

Thanks for your comments, DT

DT's 401(k) Account
Name	Shares	Market Price	Market Value	% Total Value	YTD Return	Stock Industry or Fund Category*
(FDGFX)Fidelity Dividend Growth	36.1	29.74	$1,073.61	1.28%	-1.2%	Large Blend
(FDGRX)Fidelity Growth Company	32.5	58.59	1,902.42	2.26%	-17.7	Large Growth
(FFFDX)Fidelity Freedom 2020	58.7	13.34	783.06	0.93	-5.2	Large Blend
(FFIDX)Fidelity	96.3	31.92	3,073.90	3.66	-2.6	Large Blend
(FDIVX)Fidelity Diversified International	30.7	19.91	611.24	0.73	-9.3	Foreign Stock
(FSMKX)Fidelity Spartan 500 Index	40.2	85.17	3,423.83	4.07	-6.6	Large Blend
Account total:			10,868.06	12.93%
DT's IRA Accounts
Name	Shares	Market Price	Market Value	% Total Value	YTD Return	Stock Industry or Fund Category*
(AMSTX)Ameristock	118.4	42.68	$5,053.31	6.01%	4.9%	Large Value
(FDGFX)Fidelity Dividend Growth	214.2	29.74	6,370.31	7.58	-1.2	Large Blend
(FMCSX)Fidelity Mid-Cap Stock	141.1	24.63	3,475.29	4.14	-5.1	Mid-Cap Growth
(FGRIX)Fidelity Growth & Income	79.5	39.75	3,160.13	3.76	-5.8	Large Blend
Home Depot(HD)	50.0	47.70	2,385.00	2.84	2.1	Home Supply Stores
IBM(IBM)	50.0	114.35	5,717.50	6.80	33.3	Computer Equipment
TriQuint Semiconductor(TQNT)	100.0	20.11	2,011.00	2.39	-51.9	Semiconductors
(UMBWX)UMB Scout Worldwide	98.3	19.60	1,926.68	2.29	-7.8	Foreign Stock
Wal-Mart Stores(WMT)	100.0	49.75	4,975.00	5.92	-7.9	Department Stores
(WAAEX)Wasatch Small Cap Growth	66.7	30.43	2,029.68	2.42	8.3	Small Growth
Cash	6,475.0	1.00	6,475.00	7.71	n/a	Money Market Fund
Account total:			43,578.90	51.86%
DT's Roth IRA Accounts
Name	Shares	Market Price	Market Value	% Total Value	YTD Return	Stock Industry or Fund Category*
(FCNTX)Fidelity Contrafund	56.6	44.41	$2,513.61	2.99%	-10.2%	Large Growth
(FCVSX)Fidelity Convertible Securities	276.5	20.79	5,748.44	6.84	2.0	Convertibles
Ivax(IVX)	75.0	37.50	2,812.50	3.35	24.0	Pharmaceuticals
(ROGSX)Red Oak Technology Select	219.0	12.56	2,750.64	3.27	-41.9	Specialty-Technology
(VFINX)Vanguard 500 Index	85.5	114.15	9,759.83	11.62	-6.8	Large Blend
(VGEQX)Vanguard Growth Equity	129.0	10.88	1,403.52	1.67	-18.7	Large Growth
(WOGSX)White Oak Growth Stock	104.0	44.14	4,590.56	5.46	-30.9	Large Growth
Account total:			29,579.09	35.20%
Portfolio total:			84,026.04	100.00%
*Morningstar categories

DT,

You're doing a great job in funding your retirement accounts. Barring any cataclysmic events, and assuming you continue with these contributions, you're on track to retire in your early 60s. Funding the children's college accounts is a separate matter that I'll get to later in the column.

My first observation is that you own more than 30 different mutual funds in seven separate retirement accounts. I say more than 30 funds because (FFFDX)Fidelity Freedom 2020 is a fund of funds investing in 17 different Fidelity mutual funds as its investments. As you point out, most of your mutual funds specialize in large-capitalization stocks. Twenty-eight percent of your stock and mutual fund investments are classified as large-cap value and 50% are classified as large-cap growth. But only one of the large-cap funds, (AMSTX)Ameristock, is classified as a pure value fund. Morningstar classifies the other large-cap funds as either growth funds or funds that are a blend of growth and value.

As you might expect, there's a lot of stock overlap in your mutual funds. Three stocks: Fannie Mae(FNM) , Cisco (CSCO) and Pfizer(PFE) are owned by 10 of your mutual funds. Because of how small the positions are, the overlapping investments don't overweight these stocks in the portfolio. For example, Fannie Mae is just 1.39% of your portfolio. Overweighting in your portfolio comes more from buying shares in stocks, like your positions in IBM(IBM), Wal-Mart(WMT), Home Depot (HD) and Ivax(IVX). So it's not a surprise that compared with the S&P 500 your portfolio is overweighted in the technology, retail and health sectors.

There's nothing wrong with placing additional emphasis on a stock or a sector of the economy as long as you're aware of it. My rule of thumb is that when you feel you can identify the stocks that will outperform in a sector, you should buy the stocks, and when you can't identify the winners but feel that a sector will outperform, then you should buy the sector.

You're investing in (ROGSX)Red Oak Technology Select, a technology fund where the fund managers are 100% invested in technology and concentrate the fund's investments in about 25 stocks. You also have three other funds, (WOGSX)White Oak Growth, (FCVSX)Fidelity Convertible Securities and (VGEQX)Vanguard Growth Equity, in which each has more than 40% of its investments in the technology sector. Investing in IBM and TriQuint Semiconductor(TQNT) on top of these fund investments shows a lack of confidence in your fund managers' abilities to pick technology stocks, especially since the combined position in the two stocks represents 10% of your retirement portfolio's value.

One thing you should be clear on is why you've got 8% of your retirement portfolio invested in a money market fund. If you're waiting for higher bond yields before investing in the bond market, that's one thing, but waiting out a stock market correction is another. If you think the stock market is heading south, then your cash allocation is too low. If you think the stock market is heading higher, then it's too high. And if you answer honestly and say you don't know, you should keep your cash reserves in a taxable account where you can access them without penalty, and get the cash in your retirement portfolio reinvested in stocks.

Because you can trade with impunity in these tax-deferred and tax-advantaged accounts, there's no reason not to invest with a cohesive strategy. Bump your investment in the index funds to 20%-25% from its current 16% level. Either drop the Freedom 2020 fund, or move some of your other money with Fidelity into this fund. And when you decide to buy individual stocks, make sure you're not second-guessing your fund manager's picks. Ideally, I'd like you to invest in stocks that you like in market sectors that are underrepresented by your mutual fund investments, not overrepresented.

Finally, if the goal of the UTMA accounts is to fund the children's college educations, recent changes in federal law should make Section 529 plans a better option, rather than continuing to contribute to the UTMA accounts. That's because qualified distributions from Section 529 accounts will be free of federal taxation. Many states already offer tax breaks on the investment earnings or contributions in these accounts to state residents. In general, the new law's provisions are effective for taxable years beginning after Dec. 31, 2001 (for more on how Section 529 plans work, see this TSC article).

Also, the maximum contribution to education IRAs has increased. Talk to your tax professional to discuss how these changes might alter your approach to funding the children's college education. The College Savings Plan Network provides a good overview of the changes to college savings plans brought about by the recently passed tax bill. I also suggest taking a look at the college cost calculator at USNews.com. You've got 25 years until your planned retirement but only about 10 years until your oldest child will be starting college.

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