Many of us are faced with the dilemma of putting money into a 401k due to the tax-advantages, but only being presented with limited investment options. Personally, up until now to have 401k’s all run by the giant Fidelity, but this time around we were faced with smaller company. I’ve never heard of them before, so I’ll just call them “In House” funds.

Here’s how I systematically picked out the best funds from my menu of choices. It follows my investment belief that the best long-term performance can be gained with primarily passive, low-cost, and asset-allocated portfolios.

As a preface, I should say that I treat all my accounts as one – 401ks, 403bs, Traditional IRAs, Roth IRAs, SEP-IRAs, and any taxable accounts meant for retirement. Even between my wife and I, all of it is taken together. I then try to make them follow the asset allocation I chose.

I’m not a financial professional, so don’t take this as financial advice, ya hear? It’s just what I did:

1) Make a list of each mutual fund, including the name, the asset class it represents, any front-end or back-end loads, and the net annual expense ratio. You may need to read the prospectus for each fund, or at least grab the ticker symbol and use the quote from Morningstar.com to determine these values. Here’s my list, luckily all of them were no-load funds:

2) Throw out any asset classes that aren’t included in your chosen asset allocation. For example, I am not interested in any stable value/money market funds, or any Small Cap Growth funds for my retirement portfolio right now.

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Summary and Performance
This is my first update in almost 3 months (June update), as between the move and new jobs, there hasn’t been much activity to report. I finally managed to deposit some money and bought $10,000 more of a Total US Stock Market fund yesterday in a lump sum, despite some hesitation. It will be interesting to see what happens in the financial market today and the next few months.

I did manage to calculate my portfolio’s personal rate of return, which were 3.2% year-to-date, and 4.5% annualized for 2007. Positive returns came from the Emerging Markets and International stocks, while my REITs and US Small-Cap Value funds haven’t been doing so hot.

Why do I continue to neglecting my asset allocation? The reasons remain the same. The first part is that many of my intended moves might be considered performance-chasing, such as a desire for a larger international allocation and slightly more bonds. Sometimes it’s hard to tell if the change is actually warranted or if you’ve just been listening to too much CNBC or mainstream personal finance media. The second part is that I don’t want to be one that changes asset allocations every other week, so if I do change things I want to it with lots of research and justifications… and I’ve been a bit disinterested in reading about asset allocation recently.

I’ve been really bad at regularly making contributions to my Self-Employed 401k from Fidelity. I had only planned to put $500 a month into it for the first part of the year, since I wanted to keep as much liquid cash as possible in case I bought a house. Now that it seems like (1) we’ll have enough money both buy a house and contribute to the 401k, (2) we’ve may not buy right away anyhow since we can’t agree on what we want, and (3) the year is quickly coming to an end, I went ahead and sent in a lump sum of $10,000 to catch up!

My problem: The money just showed up on my account today, so I will have to wait until Monday to trade. This is the same day Mr. Bernanke plans on making his Fed Funds rate announcement, which will either calm the market down (drop 0.25%), make it really unhappy (keep it the same), or make it really happy (drop 0.5%). Even with the subprime mess, I am definitely still going invest my money into the stock market… but should I do it all at once?

Usually, in the arena of dollar cost average vs. lump sum my position has been:

If you already have all the money available (not if you’re just taking a set amount out of each paycheck) and you are well away from retirement, you should just invest the lump sum all at once.

This is supported by several studies, including this FPA Journal article Lump Sum Beats Dollar-Cost Averaging, which concludes:

Given a lump sum, is it better to invest the entire amount immediately, or spread it out in equal installments? Based on historical evidence, the major conclusion of our study is that the odds strongly favor investing the lump sum immediately. This conclusion emerges after comparing annualized monthly returns for both DCA and LS strategies for all possible 12-month periods from 1926 to 1991. For the entire 65-year period, the LS strategy produced superior returns approximately two-thirds of the time, and the superior returns were statistically significant.

So it turns out 2/3rds of the time you win out, and 1/3rd of the time you lose. Not bad. The next argument that some people make is DCA is more of a risk-reduction method than anything else. Again, multiple academic articles suggest that DCA may not be a very efficient way to reduce risk, either! Bummer.

Still, given the Bernanke situation, I am considering dollar-cost-averaging $1000 a day over the next two weeks instead of $10,000 all at once on Monday. Prudent idea, or backtracking?

I’m swamped today, so here are some posts from the past that fill requests from my suggestion box:

My 401k to IRA Rollover Decision Process
Part 1 – Stay put with old 401k?
Part 2 – Roll over into Fidelity?
Part 3 – What about Vanguard?
Part 4 – My Final Decision

Although this was done two years ago with my previous job, I think it still contains a lot of pertinent information. Note that Vanguard has since gotten rid of their low-balance fee if you accept electronic delivery of statements.

Also, since then there are now brokers that have free ETF trades, most prominently Zecco Trading (no minimum balance, $30 IRA annual fee) and WellsTrade ($25,000 minimum equity, no annual fee).

About Prosper.com – Person-to-Person Lending
Prosper Lending Review, Part 1: First Looks
Prosper Lending Review, Part 2: The Numbers
Prosper Revisited: Will Returns Drop As Defaults Increase Over Time?

I’m still not sold on Prosper’s risk/return characteristics to consider it a prudent part of my investment portfolio, but it can certainly be a fun diversion if you like that sort of thing.

I don’t do market predictions, but I wanted to keep some things in perspective. In the most recent edition of A Random Walk Down Wall Street, there is an updated version of a chart which I have used before to show how important time horizon is to reducing your projected risk. I have replicated it below:

The fact that the variability in returns decreases the longer one stays in the market is very encouraging news for the long-term investor. But it is critical to remember that this data assumes you buy and hold a diversified portfolio. If you buy or sell stocks based on fear or hype, all bets are off.

Next up is a model portfolio by actor and personal finance columnist Ben Stein. I have read and reviewed two books he wrote with Phil DeMuth – Yes, You Can Still Retire Comfortably! and Yes, You Can Time The Market!. I actually ran across this information last week while waiting at a Barnes and Noble for my companions to finish shopping. I wrote down that it was in Forbes magazine, but I found the article online under Fortune. Either way, here it is:

Ben Stein Model Portfolio

Asset Allocation For 80% Stocks/20% Bonds (with ETF examples)
25% Total US Stock Market (VTI, IYY)
25% S&P 500 Index (IVV, SPY)
15% Foreign Developed Equity (EFA, VEA)
5% Emerging Markets (VWO, EEM)
5% Real Estate (VNQ, ICF)
20% Cash

Commentary
On the equity side, I guess he’s leaning towards only having about 15% of the domestic equity portion being Small/Mid Cap stocks, since about 70% of the Total US Stock Market index is made up of the S&P 500 anyways. His exposure to Real Estate is very small, especially compared to the Swensen portfolio we just looked at. He does add a specific allocation to Energy sector stocks to the mix, which you don’t always see.

On the fixed-income side, Stein doesn’t recommend any type of bond, corporate or not. He thinks long-term bonds are too risky, while short-term bonds don’t offer enough yield to warrant not just holding cash instead. I’m not sure if this is solely due to the current flat interest rate curve. This may also be because he seems to take the view that your emergency fund cash should be included in your asset allocation. (I like to keep it separate.)

See here for other model portfolios from respected sources, part of my incomplete Rough Guide to Investing.

This model portfolio is taken from Unconventional Success by David Swensen. As mentioned before, Swensen is not a personal financial advisor, but is a respected institutional money manager who currently runs the Yale Endowment. In his book for individual investors, he writes that there are only a limited number of core asset classes in which one should invest in. Although he avoids giving specific asset allocation guidance, he does provide an “outline of a well-diversified, equity-oriented portfolio”, which is shown below.

(Hurrah, I found my software disks so I can make pretty pie charts again!)

Asset Allocation For 70% Stocks/30% Bonds (with ETF examples)
30% Domestic Equity (VTI, IYY)
15% Foreign Developed Equity (EFA, VEA)
5% Emerging Markets (VWO, EEM)
20% Real Estate (VNQ, ICF)
15% U.S. Treasury Bonds (SHY, IEF)
15% Inflation-Protected Securities (TIP)

Commentary
There is a healthy portion devoted to real estate in the portfolio. The common way to track this asset class with REITs, which are considered a domestic stock. Instead of taking up less than 5% of the US stock market by capitalization, it is now taking up more than 40% of the domestic equity portion. I’m not really sure why there is so much, although he does write that if you own your home or other real estate, you may want to reduce your REIT exposure.

In addition, corporate and mortgage-backed bonds are left out, following his opinion that they aren’t the most desirable asset classes for individual portfolios due to added call risk and credit risk. (If you’ve been keeping up with the markets recently, it seems he may have been on to something here.)

As with all the model portfolios, the idea here isn’t just to follow any of them blindly. I do think it helps to see where different experts have similar components to their model portfolios, and where they differ. I also like breaking it down this way into pie charts of stocks-only and bonds-only in order to visualize them better.

See here for other model portfolios from respected sources, part of my incomplete Rough Guide to Investing.