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Asset Location Can Be Almost As Important As Asset Allocation


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Asset Location Can Be Almost As Important As Asset Allocation

By Lars Olson, CFP®, ChSNC™, CPFA, CAP®, CRPS®
President, Wealth Advisor
Alluvial Private Wealth

I am not a neat freak, but I do believe that everything has its place. I’ve wasted far too much time searching for my keys & wallet over the years, and it’s always frustrating. My daughter loves to cook, and I have often heard her call out from the kitchen, “Where’s the measuring cup…” or “Where’s the vanilla…” or “Who took the mixer?”

Maybe you’ve experienced similar situations looking for something that’s not where it should be.

Yes, everything should have its own place – and that’s true for your portfolio as well.

Different types of investments each have their own unique characteristics. Bonds pay income – either taxable or tax-free. Stocks grow over time. Actively managed stock mutual funds have high portfolio turnover and make capital gain distributions. Passive stock ETFs typically have very little portfolio turnover, and therefore pay much less or even no capital gains distributions.

Different types of investment accounts also have their own unique characteristics – which make them a great location for specific types of investments. By locating each type of investment in the proper type of investment account, you can optimize your finances. Let’s look at a couple examples:

Roth IRAs offer tax deferred growth over time as well as tax-free qualified distributions. Unlike a traditional IRA, there are no required minimum distributions (RMDs) after you hit age 72. So the Roth IRA can be a great tax-free growth vehicle over your whole lifetime – whether you live to be 85, 95 or 105. Therefore, you should locate only your highest growth investments in your Roth IRA. Low growth investments like cash and bonds generally shouldn’t be located in a Roth IRA.

The traditional IRAs is similar to a Roth in that it provides tax deferred growth over time but differs in that you do have to take taxable RMDs after age 72. Traditional IRAs are a great location for a balanced portfolio of actively managed stock funds and taxable bond funds. Actively managed funds are particularly well-placed in your traditional IRA because the IRA can receive the fund’s capital gains distributions without a tax consequence each year. Taxable bonds are great in an IRA, but you should almost never locate a tax-free municipal bond inside an IRA.
After tax individual or joint investment accounts are a great location for your more conservative holdings. When life’s sometimes surprise expenses hit, your after-tax accounts will be the first place you go to pay those expenses. By locating conservative investments like an emergency fund of 6 months’ living expenses and a short-term tax-free bond ladder in your after-tax account, you can be confident that you can cover life’s expenses. After-tax accounts are also a great location for passive stock index funds, which generally don’t pay capital gains tax distributions each year.

So, to sum up, each type of investment account has different characteristics that can make it a good location for different types of investments. Locating investments in their proper accounts can help you maximize your tax-free growth and minimize your annual tax burden. At Alluvial, we believe that asset location can be almost as important as asset allocation. We might not be able to help you find your keys, but when it comes to your wallet, we can advise you on smart locations.

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