Could Asset Location Make Your Investments More Tax Efficient?

What happens when you get a group together that consists of financial planners, CPAs, estate planning attorneys and investment managers? Usually when that happens for me, it means that a bunch of my friends are getting together to go watch one of our friend’s bands play or we’re playing poker. And, it also means that the topic is eventually going to become a financial one and inevitably there will be people on opposite sides of an issue so debate is a certainty.  The great thing about the debate is no matter what side you’re on, you learn something you didn’t know before the debate. One of our recent debates was about asset location. 

What is asset location? Simply put, asset location deals with the type of account that holds your various investments. Taxable accounts, IRAs, 401ks, Roth IRAs…where is the best place to hold taxable investments like bonds? Dividend-paying stocks? Growth stocks?  Does it really matter?

This article talks about asset location and how it can be additive to your overall financial life. In fact, Morningstar is tracking a new statistic and they are calling it gamma. Gamma is the additional return that an investor can earn through strategic financial planning efforts, including tax efficiency and asset location.

So what is the answer?  There is some debate in the financial community about the best accounts to hold various investment types, but I’ll share my opinions on the topic:

If you have money in taxable accounts, they are ideal accounts to hold stocks. Why? Stocks don’t always go up. At least, not the ones I buy! Using a taxable account for stocks allows you to take advantage of tax losses and favorable long term capital gains tax treatment.  And, if the stocks pay dividends, the most favorable tax treatment of dividends comes from taxable accounts as well. IRAs and 401ks are great vehicles for holding tax inefficient investments like bond funds, real estate investment trusts and commodities.  The tax inefficient investments get sheltered through a tax deferred account. Roth  are great for holding high growth investments since all of the growth can be withdrawn tax free during retirement.

It’s not always this simple since we don’t all have all of these account types and we all have different tax rates. Your age, your investment philosophy/risk profile, your long term goals as well as other factors may all influence your decisions regarding asset location.  All of your accounts don’t have to be invested identically.

What can you do? Look at your investment holdings. Is your overall stock vs. bond vs. cash allocation appropriate for your goals? That’s always the best place to start.  It’s not the most exciting part of investing (there’s a lot more sizzle in talking about what stocks might be the next Apple or Google) but it’s the part that drives ~90% of your return.

As you make changes to your overall allocation, consider the tax impact of your investment holdings.  If some changes would be appropriate for the location of your assets, think about the opinions above and if you have additional questions, you can always ask us a question on Facebook!  The IRS treats your investments differently.  Maybe you should, too.

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