You may be very familiar with asset allocation, which is a summary of what investments you own.
Dividing your investments among different assets: stocks, bonds, real estate, etc.
We’ve stressed the importance of building a portfolio that aligns with your risk tolerance, goals, and the direction of where you want to go.
Remember – the optimal portfolio for you is one where you can live with the ups and the downs.
But a lot of investors don’t take into account asset location.
Where you put your money can be equally as important as how you are invested. We should be looking to place our assets in accounts to get the best possible tax treatment.
Be cognizant of the tax efficiency and the frequency of taxable events of your investments.
So, ask yourself, “What am I building?”
There are three types of accounts: taxable (investment account), tax-deferred (Traditional IRA & 401k), and tax-exempt (Roth IRA & Roth 401k).
Taxable Accounts: Inside your investment account, ETFs would be more advantageous compared to a mutual fund. Mutual funds can kick off capital gains, usually at the end of the year, for which you are liable for that tax bill if you own this within your investment account.
High-Yield savings accounts and CDs have been all the buzz lately. Earning 4-5% on your cash is great, but then you pay taxes on that interest…
So if I’m in a high tax bracket, why not buy tax-exempt bonds, Treasury bills (exempt from state taxes), or a municipal bond fund to lower my ‘tax drag’?
Tax loss harvesting can also come into play within your investment accounts to help decrease your tax bill.
Do not own municipal or tax-exempt bond funds in a retirement account, as you get no tax benefit in doing so.
Tax Deferred Accounts: In an ideal world, you don’t think about taxes until you begin taking money out of these accounts, usually after 59 1/2. And when you do take a distribution from a traditional IRA or 401k, this is recognized as ordinary income.
Investments in these types of accounts may include growth stocks, taxable bonds, REITs, and dividend paying stocks. If you own mutual funds within a tax deferred account, and they kick off large capital gains, you aren’t liable for taxes now.
You can use those proceeds to reinvest back into the funds, which can be a great way to let the power of compounding go to work.
Tax Exempt Accounts – These accounts are arguably the most powerful. Although there are exceptions, you typically can’t access these funds until 59 1/2. But they provide major advantages such as tax-free withdrawals and no RMDs.
During retirement, you can develop a strategy on when to take from a tax deferred account and when to take from a tax-exempt account.
Similar to above, investments in these types of accounts should include growth stocks, taxable bonds, and dividend paying stocks.
When constructing your portfolio and deciding where those investments sit, you want to give yourself options. Spread your investments out in different funds and accounts.
This will provide you with the financial flexibility you need when the unexpected pops up in your life.
Cash flow and liquidity are paramount during retirement. Giving yourself options can help keep your income controlled, which may help to avoid Medicare surtax and other medical premiums.
Even if you are young, asset location should influence your investment selections.
Put yourself in a good position now.
We love to complain about paying taxes, but more often than not, this can be one of the easiest fees/costs that you can reduce.
If you have questions about your asset allocation or location, please reach out to us!
Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All indices are unmanaged and may not be invested into directly.
All investing includes risks, including fluctuating prices and loss of principal.