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October 26, 2023
In the complex world of personal finance, asset location is the hidden strategy that smart investors use to gain a distinct advantage. Most people know to diversify their investments across different asset types to create the right asset allocation. But, not everyone has an asset location strategy – consciously distributing their money across different tax treatments.
Where asset allocation establishes your investment mix across asset classes, asset location involves distributing specific assets between taxable, tax-deferred and tax-exempt accounts to minimize taxes and maximize your portfolio’s after-tax returns.
It has the potential to enhance your portfolio’s performance and minimize your tax burden. In an era where smart financial decisions are paramount to achieving your financial goals, understanding asset location is an essential tool in the arsenal of every investor.
By allocating your assets strategically, you can potentially:
Different types of accounts have different tax treatments. You can think of taxable, tax-deferred and tax-exempt accounts as three “tax buckets”:
Asset location strategies involve strategically placing specific investments in various types of accounts (taxable, tax-deferred, or tax-free) to maximize after-tax returns and minimize overall tax liability.
Here are a few considerations.
A tax-efficient asset is an investment or financial instrument that is structured or managed in a way that minimizes the tax liability associated with it. These assets are designed to generate income, capital gains, or other returns while reducing the impact of taxes, allowing investors to keep more of their earnings.
Tax-efficient assets are particularly important for individuals seeking to maximize after-tax returns and minimize their tax burden. Common examples of tax-efficient assets include:
The following tax-efficient investments would generally fit well in taxable accounts:
The following investments are generally less tax-friendly and would typically be well-placed in tax-advantaged accounts:
Asset location can play an important part in tax-efficient investing. It allows you to keep more of your investment returns by accounting for how different assets are taxed in different accounts. Evaluating and modifying your asset location is a prudent strategy when goals, income or tax brackets change.
If you hold a taxable account in your investment portfolio, you may want to consider exploring a few tax planning opportunities that could benefit you.
Just like you can shift your asset allocation, you can sometimes also switch your asset location to optimize for taxes.
Since your mix of stocks, bonds and cash drives the vast majority of investment returns over time, it’s important to keep asset allocation decisions a top priority. Asset location focuses on tax-efficiency and, while beneficial, the tax impact is secondary to asset allocation in its effect on total returns for the typical investor.
While asset allocation should be the primary focus, asset location can provide value, especially for larger investment portfolios with multiple tax buckets as discussed above. Strategic placement of investments across taxable and tax-advantaged accounts can further boost after-tax returns. However, in the end, it’s the asset allocation, not location, that should steer your overall investment strategy.
Let the NewRetirement Planner help you visualize your asset location and strategize for how to do better. This easy to use tool puts the power of planning – even tax visualizations – into your own hands.
Want more about taxes? Explore 12 year-end tax tips.
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