Most investors are familiar with the concept of asset allocation, the strategic mix of stocks, bonds, and other assets held in an investment portfolio based on time horizon, risk tolerance, and goals. It lays the foundation of a portfolio and is the principal driver of an investor’s risk and return outcomes.
Complementary to asset allocation is the related concept of asset location, which focuses on optimizing tax efficiency and enhancing after‑tax returns by strategically selecting the most suitable accounts for holding various investments. It involves the thoughtful placement of assets within taxable, tax‑deferred, and tax‑exempt accounts and creates greater flexibility, opportunities for tax efficiency, and more options for income sourcing during different life stages and throughout retirement.
Asset location goes beyond deciding which investments to include in a portfolio. It involves carefully choosing the types of accounts in which these investments are held, based on the differing tax treatments of income generated by the assets. As a result, investors should understand the differences between account types and their interaction with various investment income (interest, dividends, royalties, etc.), withdrawals, and appreciation.
When considering an asset location strategy, the first step includes conducting a detailed analysis of household assets, understanding their income characteristics and whether they generate interest, dividends, or capital gains, and how these assets are taxed.
This analysis not only involves identifying the types of assets held in a portfolio, but also the different investment vehicles, which can include mutual funds, exchange‑traded funds (ETFs), and separately managed accounts (SMAs), REITs, interval funds, and limited partnerships, to name a few.
Asset location can play a key role as part of a comprehensive financial plan, significantly influencing tax efficiency and long‑term after‑tax portfolio performance. By strategically placing assets in the right accounts based on tax treatments, investors can potentially enhance after‑tax returns and achieve financial goals more effectively.
Personal finance articles rarely address where investment assets should be placed. Yet, coordinating your asset allocation with your asset location, though daunting, can bring tremendous wealth maximization benefits. True wealth management, what we attempt to help clients with, moves beyond a selection of stocks and bonds and seeks wealth optimization via holistic planning and asset selection and conscious placement.
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