Tax-Smart Investing Strategy: Asset Location

Asset location is a tax-efficient investment strategy that places different types of investments into specific accounts based on their tax treatment. The goal? Minimize taxes and maximize after-tax returns.

Some investments, like bonds and REITs, generate income taxed at higher rates. These are best held in tax-advantaged accounts (such as IRAs or 401(k)s), where taxes are deferred or eliminated. Meanwhile, tax-efficient investments, like stocks, can be placed in taxable accounts to take advantage of lower capital gains tax rates.

While asset location isn’t required for investment success, it acts as a final layer of optimization—a way to enhance your returns while complementing other key investment strategies, such as:

  • Broad diversification – Spreading investments across various asset classes (stocks, bonds, real estate) rather than concentrating in one.
  • Low-cost investing – Minimizing fees to maximize net returns.
  • Appropriate asset allocation – Adjusting your stock/bond mix based on your time horizon and financial goals.

Asset Location: A Long-Term Commitment

Asset location is a strategy that unfolds over years, even decades. Like any investment approach, it has challenges worth considering:

1. Each Account Will Perform Differently
If an investor has a 90% stock and 10% bond allocation, every account—taxable, pre-tax IRA, Roth IRA—may be structured differently. For example:

  • A bond-heavy pre-tax IRA might grow only 3% in a year.
  • Meanwhile, a stock-heavy taxable account might grow 16% in the same year.
  • In a down market, one account might lose 3%, while another drops 20%.

This disparity can feel uncomfortable, but asset location is a portfolio-level strategy, not an account-level strategy. Instead of focusing on individual account performance, look at the total portfolio’s performance.

2. Asset Location Adds Complexity
A simple approach keeps all accounts invested the same way—easy for deposits, withdrawals, and rebalancing. With asset location, however, adjustments must be made across multiple accounts to maintain the overall allocation while following tax-efficient principles. This requires more planning and oversight.

3. Changing Tax Laws Can Impact Asset Location’s Benefits
The primary benefit of asset location is reducing taxes. The higher the tax rates, the more valuable the strategy. However, tax laws change. If tax rates decrease, the benefits of asset location may shrink. Conversely, if rates rise, asset location becomes even more valuable.

For example, placing REITs in tax-advantaged accounts was once a clear-cut strategy. But newer tax rules now allow some tax benefits for holding real estate in taxable accounts, reducing the advantage of keeping them in an IRA or 401(k).

Asset Location Guidelines

Rules Based on Tax Efficiency

  • Place tax-efficient investments in taxable accounts
    • Example: A total U.S. stock market index fund
      Why? Tax-efficient investments generate minimal taxable income, making them well-suited for taxable accounts.
  • Place tax-inefficient investments in tax-advantaged accounts (IRA, 401(k), etc.)
    • Example: A taxable bond fund
      Why? Bonds generate significant taxable income, so keeping them in tax-advantaged accounts shelters them from taxes.

Rules Based on Growth Potential

  • Hold low-growth investments in pre-tax accounts (Traditional IRA, Traditional 401(k))
    • Example: A total U.S. bond market fund
      Why? Withdrawals from these accounts are taxed as ordinary income, so keeping lower-growth assets here helps minimize future taxable distributions.
  • Hold high-growth investments in tax-free accounts (Roth IRA, Roth 401(k), HSA)
    • Example: An S&P 500 fund
      Why? Since withdrawals from these accounts are tax-free, high-growth assets can compound without future tax consequences.

A Special Rule for International Stocks

  • Hold international stock funds in taxable accounts
    • Why? International funds often pay foreign taxes, and by holding them in a taxable account, you can claim a foreign tax credit to reduce your U.S. tax bill. If held in a tax-advantaged account, this credit is lost.

Why Do Tax Efficiency and Growth Potential Matter?

Both tax efficiency and growth potential play crucial roles in maximizing long-term investment returns.

  • Tax efficiency ensures that you keep more of your money by minimizing taxes. Bonds, for instance, generate taxable income, while index funds are more tax efficient. Placing tax-inefficient assets in tax-advantaged accounts shields them from high taxes.
  • Growth potential determines how much your investments appreciate over time. High-growth assets, like stocks, perform best in tax-free accounts (Roth IRAs, HSAs) so they can compound tax-free, while lower-growth assets are better suited for taxable or tax-deferred accounts.

By strategically considering both tax efficiency and growth potential, you can optimize your portfolio for greater after-tax returns and long-term wealth growth.

Balancing Optimization with Simplicity

These guidelines don’t have to be followed perfectly. You don’t need to place all your stock holdings in a Roth IRA or all your bonds in a 401(k). Even partially implementing asset location—such as holding a good portion of your stocks in a Roth—can significantly boost your long-term savings.

At a high level, asset location is easy to implement, but the real challenge lies in balancing optimization with simplicity.

Final Thoughts: Is Asset Location Right for You?

Asset location isn’t essential for investment success, but it’s a powerful optimization strategy that can enhance long-term returns. It works best when:

  • You’re focused on after-tax returns, not just pre-tax performance.
  • You’re comfortable with different accounts performing differently.
  • You don’t mind a bit of extra complexity to maximize tax efficiency.

Even if you prefer simplicity, loosely following asset location principles can lead to meaningful tax savings and wealth growth over time. Whether fully embracing asset location or applying key principles, it can be a valuable addition to your investment strategy.

Copper Leaf Financial’s leadership team includes licensed CPAs and Certified Financial Planner® professionals who can contribute an expert understanding of how taxes impact ALL your financial decisions about retirement, estate planning, investments and insurance.

Contact us today to schedule a free consultation.

Recipients should not act on the information presented without seeking prior professional advice. Check with your advisor about your specific situation or contact Copper Leaf Financial at 802.878.2731.

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