Asset location pertains to the types of investment assets that are best held in various types of accounts. Asset location is a tax minimization strategy that matches various types of investments with the type of account best-suited for that type of investment holding.
Asset location is about strategically holding investments in accounts where you are likely to achieve the highest after-tax returns. This includes taxable investment accounts, tax-deferred accounts such as a traditional IRA or 401(k), or tax-free accounts which are usually Roth accounts.
Due to the nature of dividends, interest, or capital gains connected with certain types of investments, it might be most tax-efficient to hold them in one type of account versus another. This is the essence of asset location.
While it is not always possible to align your entire portfolio in a perfect fashion in terms of asset location for each holding, it does make sense to pay attention to this when deciding which investment holdings fit best into your various accounts.
The following types of holdings can be well-suited for a taxable account:
Note at this writing we don’t know what, if any, changes the current administration might propose to the tax rates for long-term capital gains. If capital gains rates are drastically increased as some have speculated, this might change some of our thoughts above.
Certain types of investments may be best suited for tax-deferred retirement accounts such as traditional IRA and 401(k) accounts or tax-free Roth accounts. Some examples include:
Asset location can be an important consideration in investing as we all want to invest in the most tax-efficient way possible.
In our opinion, however, asset allocation should govern your investing strategy. This includes the types of investment vehicles, the asset classes included in your portfolio, and the percentage amounts allocated to each of the various asset classes.
Sometimes your situation doesn’t allow you to perfectly align the asset location of every holding within your portfolio. This might be a function of the relative size of the balances in your various types of accounts or other factors.
Where appropriate and feasible, we feel that using asset location principles to determine which holdings are located in various types of accounts makes sense for most investors. However, we would caution investors to use good common sense in implementing an asset location strategy.
For example, incurring unnecessary taxable income to realign your portfolio generally defeats the whole purpose of asset location which is tax savings.
There are a number of ways to realign your portfolio to be more in line with an asset location strategy that best fits your situation. These include:
When considering an asset location strategy for your portfolio, it's important to keep both current and future tax implications in mind. For example, will you be in a higher or lower tax bracket in retirement?
Asset location should be implemented as part of your overall financial plan and your investing strategy. If done correctly, asset location can be a key tool in your tax planning efforts.
If you are looking for a fee-only fiduciary financial advisor who will always put your interests first, please give us a call to discuss asset location or any other financial issues. We are here to help.
Bill Canty, CFP®, CPA
Ed Canty, CFP®
Joe Canty, Investment Advisor Rep.
Maureen Walsh, EA, Investment Advisor Rep.
Tina Alteri, CPA, Tax Advisor