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Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

Investing's magic formula: Allocation plus annual rebalancing

Dear Dollar Diva,
I have my IRA account invested with a stock brokerage company.  Some of the funds are invested in stocks, but I have over $20,000 in a cash reserve fund. How can I purchase Series I bonds with this cash reserve? I have checked with my broker and the manager of my local bank, and both said they couldn't do it.
Jerome

Dear Jerome,
You can't buy I bonds for an IRA account. The financial institutions will give you a song-and-dance about how a special trust fund account is required, and they can't set one up, and how ever-so-sorry they are, but the bottom line is, they can't make any money selling I bonds, so if you want to buy them, you're on your own.

It's really not so terrible; the interest on I bonds is tax-deferred for 30 years, anyway, and if you decide to cash them in sooner, you don't get hit with a 10-percent penalty. The Diva's "5 common questions about savings bonds" tells you where you can buy U.S. savings bonds and why they're such a good place to stash your cash.

An IRA account is a vehicle for long-term investing; the funds in it should be fully invested. The Diva's question is, unless it's a very small percentage of your investment portfolio, why on earth would you have over $20,000 in cash sitting in your IRA brokerage account? Unless you're close to the finish line, you're supposed to be using that account to invest, not save.

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Saving vs. investing
Saving is what you do for short-term goals and emergencies. Investing is what you do for long-term goals, such as retirement.

An investor's first step is to decide on an asset allocation; it might look something like this:

Investment type
Higher risk
(Best for people in their 20s and 30s)
Medium risk
(Best for people in their 40s and 50s)
Lower risk
(Best for people in their 60s and 70s)

Bonds and balanced
(part stocks & part bonds)

0%

20%

40%

Large company
(growth and income)

55%

45%

35%

Medium company
(mid-cap)

15%

15%

10%

Small company
(small-cap)

15%

10%

5%

International

15%

10%

10%

Once you have your allocation in place, select the investments in each category that you want to own. Once a year, compare your holdings to your desired allocation and rebalance. Allocation plus annual rebalancing: That's the magic formula for investment success.

The Diva explains the basics of investing in mutual funds in "401(k) allocations for twenty-somethings." You'll learn about:

  • Investment objectives: conservative or aggressive?
  • Investment style: growth, value or blend?
  • Size of company: large-cap, medium-cap, small-cap.
  • Index funds: They are the market.
  • Other funds: emerging growth, overseas, aggressive growth and bond funds.

The principles that apply to fund investing are the same as those that apply to stock investing, but most folks find it easier to pick mutual funds than to pick individual stocks.

Panic selling
The Diva hopes that your cash reserve is not the result of panic selling because the market took a dive after Sept.11. Novice investors tend to think "buy" when the market is up and "sell" when it's down; if you did that, promise that you won't do it any more.

Seasoned investors don't much care what the stock market is doing from one month to the next; they set up an asset allocation, select their holdings, rebalance their portfolios periodically and sleep well at night. They also make money over time, which is what it's all about.

-- Posted: Dec. 3, 2001

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See Also
Series I bonds: Your protection against inflation
Where do I stash my emergency cash?
Cashing in a CD can be costly
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