You’ll hear quite a bit in the financial media about diversification and the benefit of asset “allocation” but there is very little discussion on using an asset “location” strategy with your investment portfolios. Asset location refers to where or in which type of account (taxable or tax-deferred) an investor should hold certain types of assets in order to potentially maximize after tax returns for the overall portfolio.
Basics
My clients hear me go on about this concept on a regular basis. When creating portfolio recommendations, I not only want to make sure an investor’s assets are diversified across asset classes, sectors, etc., but I also like to have investments in a variety of tax account types (a taxable account versus a deferred tax account 401k or a tax free Roth) AND within those different tax-type accounts, I recommend “locating” or assigning certain assets based on their potential ability to offer (no guarantees of course) a better after tax return by assigninging them to a given account type.
Caveats
Now, if you only have tax deferred accounts — 401k or IRAs, etc. — this strategy is really not relevant to you. However, if you also hold assets in taxable accounts, using an asset location strategy can be beneficial. Asset allocation always trumps asset location decisions in my planning recommendations, but whenver it is prudent, I design portfolios using both concepts. This means that in some accounts, there may be more volatility and different performance than in others. I caution clients that in using this strategy, we keep an eye on the overall asset allocation as compared to the target benchmark and you should not compare the individual accounts as it would not be a relevant comparison.
You do need to be aware that since our wonderful and complex tax laws are constantly in flux, there is always the chance that a strategy used today will not be beneficial the next day. I don’t anticipate our tax laws changing soon and in a manner that would significantly negate the current benefit of the strategy, but it is useful to keep an eye on tax rules and how they apply to an asset location strategy.
For more information on the topic…
I’m attaching a copy of a PDF reprint by Vanguard, Asset Location for Taxable Accounts and some asset location strategy article links:
Happy reading!
Have questions? Contact Mary. This article is for informational purposes and should not be taken as legal, tax or investment advice.
