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Evaluate 401(k) as part of your total portfolio
By HELEN HUNTLEY, Times Staff Writer
© St. Petersburg Times, published September 8, 2002
Q. Can you help me make an educated decision regarding the investment choices for my 401(k) plan? The plan offers four stock mutual funds, a money market account and a company stock fund. I checked into each of the four funds, and there is a lot of overlap among their top 10 holdings.
The only other fund I own is a total stock market index fund, which I consider the core of my portfolio. Some of that fund's top 10 holdings are the same companies that these funds own. If I contribute to any of these funds am I overly duplicating my investments? I do not want to buy company stock because my 401(k) match will be in company stock. Am I looking at the top 10 holdings too closely?
A. You have the right idea. You should look at your 401(k) plan as part of your overall investment portfolio, not as a separate entity. By taking a close look at your fund's holdings, you can uncover duplication and, perhaps even more important, you can see whether the fund's investments fit its stated objectives.
I recommend taking the top-down approach to your portfolio. By that I mean you should first decide what percentage of your money you want in each major asset class: stocks, bonds and cash. This allocation should be based on your age and your tolerance for risk. The next step is to decide how you want the stock portion of your portfolio divided. While a total stock market fund instantly gives you broad diversification, there is merit to allocating some of your money to specialized sectors such as foreign stocks.
Once you know where you want to go with your investments, you can look at how closely your current portfolio matches your target allocation. Ideally, you would direct your new 401(k) investments into those areas that fall short. For example, it does not appear that you own any bonds or foreign stocks. Based on that information, it would seem to me that you would want to divide your new money between the balanced fund and the international fund available in your plan. The other two funds in the plan are very similar to what you already own.
Periodically review your holdings to make sure they remain aligned with your plan. If your allocation starts to get out of whack, redirect your money.
It is important to contribute at least enough to your 401(k) plan to earn your full employer match. Once you've done that, you might consider directing some of your savings to an individual retirement account that gives you more flexibility.
Q. I received my son's 401(k) plan balance as his beneficiary. Am I subject to federal income tax on the entire amount? The institution administering the fund deducted a fair amount already to pay the IRS.
A. The entire amount of your son's 401(k) plan is considered taxable income to you. When you fill out your tax return, the taxes already deducted should be reported on your return. The actual income tax you owe may be more or less than what was already deducted. If too much was deducted, you will get a refund.
Q. When my ex-husband and I sold our house six years ago, we used a one-time exclusion to avoid paying taxes. Now we are going to sell a small piece of commercial property which we own as tenants in common. As a single person am I entitled to any tax exclusion on the sale of this property?
A. No. You can exclude all or part of your gains on the sale of a primary residence if you lived there and owned the property for at least two of the previous five years. This tax break is not a "one-time" exclusion, but can be used repeatedly so long as you meet the requirements.
Commercial property is different. You will owe taxes on your gain, and you may need the help of a tax preparer to calculate the amount correctly.
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-- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.