The Big Picture

Managing your investments is a little like conducting a symphony orchestra. You need all of the individual parts to work well together in order to get the desired result. A common mistake is to think of every component of your portfolio as a distinct entity. It is far better to consider how each element fits in with your overall investment strategy.

Let’s suppose that you have two investment accounts, an IRA and a taxable account. You wisely set a goal of maintaining a balanced, well-diversified portfolio. But that doesn’t mean that each account has to be balanced and well-diversified" just your overall portfolio.

Your IRA is a tax-deferred account. When possible, you should place securities that generate substantial tax liabilities in this account. Stocks that pay high dividends, for example, belong in your IRA. Actively-managed mutual funds tend to be tax-inefficient, so put them in your tax-deferred account.

On the other hand, investments that generate little or no taxes should be placed in your taxable account. Municipal bonds, which are exempt from federal taxation, should always go in your taxable account. Index mutual funds, which are relatively tax-efficient, are a great choice for a taxable account. If you are a buy-and-hold investor, non-dividend-paying stocks also belong in your taxable account.

What if you have a 401(k) and are limited in your choices of tax-deferred investments? You should still keep the big picture in mind. For example, suppose you work for Pfizer and hold a sizable chunk of your company’s stock in your retirement account. You would be wise to lighten up on pharmaceutical stocks in your other accounts because you’ve already got that industry covered. Similarly, if you own two or three houses, you may want to pass on real estate investment trusts (REITs).

Finally, you should consider your unique personal circumstances. For example, if you have a stable job with a guaranteed income, you can afford a little more risk in your investment portfolio. People with a variable or unpredictable income stream, such as brick-layers or professional athletes, should think about adopting a more conservative investment strategy.

August 1, 2001

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