Why You Should Keep an Eye on the Big Picture
By Jonathan Clements, Director of Financial Education, Citi Personal Wealth Management February 04, 2013 09:00 AM
You might have a bank account, brokerage account, a few Individual Retirement Accounts and maybe money in both your current employer's 401(k) plan and also an old employer's plan. But do all of these accounts, taken together, give you a sensible investment mix?
A fistful of different accounts might offer the illusion that you've spread your investment dollars widely. But whether you are truly well diversified depends on what you own in each account and in what amounts. For instance, if all your accounts are heavily tilted toward U.S. large-company stocks, with scant exposure to bonds, U.S. small-cap stocks and foreign shares, you likely own a lopsided portfolio, no matter how many different accounts you have.
What to do? You may want to coordinate the investments in your various accounts. That doesn't just have the potential to improve your portfolio's diversification. You may also enjoy four other advantages:
- Smaller tax bills. For instance, you might aim to keep taxable bonds in your retirement accounts, where the interest you earn each year can grow tax-deferred, while favoring tax-efficient stock funds in your taxable accounts. A tax-efficient stock fund should make relatively small capital-gains distributions each year--and when those distributions are made, the maximum federal long-term capital-gains rate would be 20%, based on 2013 rates, versus a maximum income-tax rate of 39.6% For further information, consider talking to a tax advisor.
- Fewer holdings. Instead of owning, say, three emerging-market stock funds in three different accounts, you might build up a single, larger position in just one of your accounts. That will reduce the number of holdings you have to monitor. Keep in mind that, if you sell existing funds held in a regular taxable account, you could trigger a capital-gains tax bill.
- More attractive investments. As you look to shrink the holdings you have, you might cherry-pick the more promising investment choices. Let's say you check out the fund line-up in your employer's 401(k) and find it has some fine U.S. stock investments, but the international offerings are sub-par performers. You might use your 401(k) for U.S. stock exposure, while getting your foreign exposure with one of your other accounts.
- Lower costs. As you cherry-pick the more promising investments from among your various accounts, you might also look to cut your investment costs by favoring offerings with lower annual expenses.
INVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE
Citigroup Inc. and its affiliates do not provide tax or legal advice. To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.
Diversification does not protect against loss or guarantee a profit.
Bonds are affected by a number of risks, including fluctuations in interest rates, credit risk and prepayment risk. In general, as prevailing interest rates rise, fixed income securities prices will fall. Bonds face credit risk if a decline in an issuer's credit rating, or creditworthiness, causes a bond's price to decline. High yield bonds are subject to additional risks such as increased risk of default and greater volatility because of the lower credit quality of the issues. Finally, bonds can be subject to prepayment risk. When interest rates fall, an issuer may choose to borrow money at a lower interest rate, while paying off its previously issued bonds. As a consequence, underlying bonds will lose the interest payments from the investment and will be forced to reinvest in a market where prevailing interest rates are lower than when the initial investment was made.
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