What's the easiest way to allocate my IRA without spending a lot of time on research?

QUESTION: My wife and I -- ages 32 and 31 -- try to contribute the maximum to our 401(k)s and Roth IRAs. Our 401(k)s are properly diversified, which is easy to do because the choices are limited. (We hold a mix of equity and bond funds.) But with our Roth IRAs it's trickier. We want to be properly diversified, but neither of us wants to do a lot of work.

Does it make sense simply to invest our Roth IRAs in an index fund that tracks the entire market and forego bonds and international funds? What about investing in one single mutual fund that covers all of the different asset classes?

-- Anonymous

ANSWER: Asset allocation is always tricky, but getting it right is fundamental to successful investing. The good news: You're thinking along the right lines. Total market index funds and target retirement funds (funds of funds that reallocate as investors approach specified target retirement dates) are two no-fuss ways to get diversification at a low cost.

The key is to see how these types of funds could fit in with what you already hold in your 401(k)s. "You need to think of your two retirement accounts as one big pot of money and make sure it fits together in total, not piecemeal," says certified financial planner (CFP) Harold Evensky of Evensky, Brown & Katz in Coral Gables, Fla.

Which is the right way to go? Let's review how each option could mix with the rest of your retirement savings.

First, let's assume you buy the Vanguard Total Stock Market Index Fund (VTSMX), which tracks the Wilshire 5000. With a 0.20% expense ratio, it comes at the right price. But while this fund offers exposure to the entire U.S. stock market, it provides no exposure to international stocks. It also has a heavy skewing toward large caps: Right now, 71% of assets are held in large/giant-cap stocks, 20% in midcaps and only 9% in small/microcap stocks (data as of July 31, 2004, according to Morningstar).

In other words, as diversified as this fund is, it could tip your asset allocation too far into the domestic large-cap category. If you want to retain your original asset allocation, you'll have to adjust the holdings in your 401(k) so that your portfolio fits your goals and risk profile. "You need to step back and look at what it is when you put it all together," Evensky says.

From that perspective, it might seem a lot easier simply to go with a target retirement fund, since it's already diversified across asset classes. So-called lifecycle retirement funds -- also known as target retirement funds -- are typically a mix of stock and bond mutual funds appropriate for investors who plan to retire in a specific year that's included in the fund's name. A fund manager rebalances the assets as the fund's shareholders move closer to retirement, going from a greater allocation in stocks to one in bonds.

"If you go with a target retirement fund, you get a one-stop diversified portfolio that adjusts its asset allocation as the years go by," says Kerry O'Boyle, a fund analyst with Chicago-based fund tracker Morningstar.

Many big no-load fund companies, including Fidelity, T. Rowe Price and Vanguard, offer a selection of target retirement funds at low cost. The Vanguard and T. Rowe Price products average the expense ratios of the specific funds held within each target fund and charge no additional fees. Fidelity charges a mere eight basis points (0.08%) on top of the underlying funds' average expense ratio.

Picking a suitable fund may seem like a no-brainer, but investors shouldn't focus only on the retirement year. Just because a fund targets investors who are planning to retire in, say, 2035 doesn't mean its asset allocation necessarily fits one specific investor's goals and risk tolerance. "It doesn't really take the place of a financial planner," says O'Boyle. On closer examination, one could find that the fund is more conservative or aggressive than desired.

Vanguard's target retirement funds, for example, are considered fairly conservative in terms of how they allocate between equities and bonds, while T. Rowe Price funds are on the aggressive side and Fidelity is in the middle, according to O'Boyle. "That's something for investors to be aware of, as it can drastically affect their returns," he says. The Vanguard Target Retirement 2025 (VTTVX), for example, currently invests roughly 60% of assets in equities and the rest in bond funds. "Most financial advisers would consider (that) pretty conservative," O'Boyle says. With 40% or more of their portfolio in bonds over the next 20 years, investors might find themselves short of their goal when they retire in 2025 because they weren't investing aggressively enough, he adds. In contrast, the T. Rowe Price Retirement 2025 Fund (TRRHX) allocates nearly 85% to equities, and Fidelity Freedom 2025 (FFTWX) is roughly 78% stocks and 22% bonds.

Finally, while both total market index funds and target-retirement funds are great for younger investors with relatively small portfolios, investors who reach a certain ballpark figure -- Marilyn Bergen, a fee-only CFP with CMC Advisers in Portland, Ore., suggests $100,000 -- might want to take a more active interest in allocating their investments. "Now you have enough money that you don't want to be just buying something and hoping it all works out." she says. "It's too important."