Asset Location Strategy Focuses On Improving After-Tax Returns

A frequent topic of conversation during advisor / client meetings is that of asset allocation. Most investors are familiar with the basic principles of diversification and optimizing asset allocation will always be a major consideration in the pursuit of maximizing account returns.

One topic that is just as important but less frequently discussed is asset location. While the terminology sounds similar, asset location strategy has a different focus: Driving returns by lowering your overall tax obligations, by strategically placing certain investments in the most tax-efficient account types.1

In essence, an asset location strategy would consider not just what investments to choose but where to place them. For example, should a Roth IRA hold growth stocks or would they be more efficient in a taxable account? Studies have shown that tax-efficient investments – such as stocks – work better in taxable accounts, while less efficient investments like bonds and REITS are better held in tax-deferred accounts.2

Developing an intelligent tax strategy aimed at minimizing tax impacts in a portfolio has the potential to lead to increases in after-tax returns – which can lead to more client satisfaction and retention. While it’s likely that every client could benefit from asset location, investors with a particular set of criteria may be better situated to see enhancements in their after-tax returns when implementing an active asset location strategy.3 These criteria include:

  • High marginal income tax rate. Individuals in the three highest federal tax brackets could see the biggest benefit from asset location. Those living in areas with high state or local income taxes also apply here.
  • Taxable accounts holding tax-inefficient investments. A client could see immediate impact to after-tax returns by repositioning holdings in taxable accounts.
  • Investment horizon of 10+ years. An asset location strategy should be in place for at least 10 years to maximize its effectiveness, as a general rule.

Certain factors must be considered before deploying an asset location strategy. Legal constraints – including those related to federal and state income tax and federal and state gift and estate tax – may create restrictions for moving an asset into a particular account. You must also remember the stated investment objective and risk profile of an account before moving assets in or out to avoid misalignment and possible issues with regulators.

With the realignment of the income tax brackets as a result of the Tax Cuts & Jobs Act passed in 2018, many investors moved into a different tax bracket. As a result, it may be a good time to review the underlying investments in your clients’ accounts to see if there are ways you can meet stated investment objectives and risk profiles while also minimizing tax liabilities and maximizing after-tax returns for their portfolios. Remember, when working with clients on tax minimization in conjunction with portfolio maximization it is vital to include the professional guidance of a tax professional or at the very least encourage the client to seek guidance from a tax professional prior to making any final decisions regarding asset location.

 

  1. Sept. 26, 2018. “Why asset location matters.” https://www.fidelity.com/viewpoints/investing-ideas/asset-location-lower-taxes Accessed Oct. 18, 2018.
  2. Rebecca Lake. US News & World Report. Nov. 7, 2017. “How to Make a Taxable Account More Efficient.” https://money.usnews.com/investing/investing-101/articles/2017-11-07/how-to-make-a-taxable-account-more-efficient Accessed Oct. 29, 2018.
  3. Sept. 26, 2018. “Why asset location matters.” https://www.fidelity.com/viewpoints/investing-ideas/asset-location-lower-taxes Accessed Oct. 18, 2018.

641527 – For Investment Professional Use Only

The information and opinions contained herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Advisors Excel. This information is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation.

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