Q. My employer offers a 401k with several funds from Merrill Lynch and other companies. They have an investment vehicle called a Goal Manager. This is a no fee plan. It is a selection of 10 funds used to create portfolios based on five models--- conservative to aggressive. Each portfolio will be managed by a money manager and rebalanced every six months to maintain the percentage distribution of investment within the models.

I am leaning toward doing this but have not yet decided because some of the expense ratios for these funds are, in my opinion, too high. The funds are as follows according to my desire to stay moderate in my approach: 11 percent Merrill Lynch Retirement Trust; 16 percent ING Intermediate Bond; 14 percent Munder US Government; 6 percent Merrill Lynch Fundamental Growth; 6 percent American Growth Fund of America; 16 percent American Washington Mutual; 8 percent JP Morgan Mid Cap Institutional; 7 percent Merrill Lynch Small Cap Value; 8 percent Merrill Lynch Global Allocation; and 8 percent Oakmark International II.

What do you think?

---G.B., The Woodlands, TX (by e-mail)

  

A. Let's go through this step by step. First, the portfolio presented is what Morningstar would identify as a "moderate allocation" fund, with 41 percent in fixed income assets and 59 percent in various classes of equity assets. The equity assets are divided between large growth and large value portfolios as well as mid and small cap domestic companies (about 43 percent of the portfolio) with 16 percent divided between two funds that invest internationally. So it's quite well diversified.

While it is a composite of many funds, you can measure it against its category by visiting www.morningstar.com, clicking on "funds", and then, under mutual fund performance, clicking on "Category Returns."   Over time, you will be able to see how your portfolio is doing against its moderate allocation category. I suggest you do this regularly.

Second, I don't think expense ratios for the individual funds are high. Indeed, it's an admirable collection. The expense ratios range from 1.01 percent to 1.58 percent, most of the funds are rated "above average" or better by Morningstar, and most have performed in the top 25 percent of their category in the last three years. All of them have been in the top 50 percent.

If the portfolio itself is managed at no additional expense beyond the expense ratios of the funds in the portfolio, your total cost of management will probably average about 1.20 percent. The average expense ratio for the entire category "moderate allocation" is 1.27 percent; the average expense ratio for the 50 largest funds in the category is 0.99 percent.

If there was an additional cost for managing the portfolio you would have to face a different question--- Will the managers be able to recover the added cost in performance? Over the last ten years, for instance, the difference between being a moderate allocation fund at the 25th percentile and one at the 50th percentile is only 1.13 percentage points a year.

As a point of reference: one of the reasons Vanguard Balanced Index fund has done better than 75 percent of the competition in the last 10 years is that it costs only 0.22 percent a year. That's 1 percentage point a year less than the average moderate allocation fund--- nearly enough in cost savings, alone, to boost its performance 25 percentile points.

  

Q. I am setting up a trust fund for 8 grandkids. The oldest is 22 years old; the youngest is 1 year old. They will each receive the money when they become 35 years old. I would like to have four good mutual funds to invest in for the long run. Can you help me with this?

---J.Z., by e-mail from Dickinson, TX

  

A. You're talking about anticipating fund futures for 34 years. That's nearly ten times the average tenure of mutual fund portfolio managers, 3.5 years, according to the Morningstar mutual fund database. Because of the time period involved, you should consider banking heavily on low costs and tax efficiency rather than transient star managers.

In a recent interview, Vanguard founder Jack Bogle told me that he put money aside for his grandchildren by investing in the Vanguard Tax Managed Balanced fund. This fund invests about half its assets in tax-free municipal bonds and the remainder in low dividend stocks selected from the Russell 1000 index, minimizing current distributions and taxes. Over the last 5 years it has done better than 71 percent of its "conservative allocation" fund peers. On an after-tax basis this fund scores even better.

If you are willing to pay less attention to taxes (all of which depends on how large the trust is) you should go for broad diversification. You can do this at very low cost by dividing your money in equal parts between exchange traded funds: iShares Russell 3000 Index (ticker IWV) for domestic stocks, iShares MSCI EAFA (ticker EFA) for international stocks, iShares Cohen and Steers Realty Majors (ticker ICF) for real estate, and the soon to be issued iShares Inflation Protected Treasury Index for inflation protected fixed income. The last item will be launched before year-end.

Talk to your trust attorney about trust taxes and trust income distributions--- and related expenses--- before you make your investment decisions.