Asset location

Placing each investment in the account type, taxable, tax-deferred or tax-free, where it is likely to be taxed least over time.

What it means

Asset allocation decides what mix of investments to own; asset location decides where to hold each one. Because taxable brokerage accounts, tax-deferred accounts such as traditional IRAs and 401(k)s, and tax-free Roth accounts are taxed differently, the same portfolio can produce different after-tax results depending on placement.

A common approach puts tax-inefficient holdings, such as taxable bonds, REITs and actively traded funds, in tax-advantaged accounts. Tax-efficient holdings, such as broad stock index funds and municipal bonds, often go in taxable accounts, where qualified dividends and long-term gains get lower rates. Some people also favor Roth accounts for the assets expected to grow fastest.

Example

Suppose an investor has $100,000 in a bond fund paying a hypothetical 4%, or $4,000 of interest a year. In a taxable account at a hypothetical 24% rate, that costs $960 a year in tax; in an IRA, the tax is deferred until withdrawal.

How it’s used

Investors with both taxable and retirement accounts
Setting up a new portfolio across accounts
Rebalancing without triggering taxes

Strengths and weaknesses

Strengths

Can raise after-tax returns without adding risk
Works with any target asset allocation
Low cost to implement

Weaknesses

Benefits depend on future tax rates and returns
Makes each account’s mix uneven and harder to track
Little value for someone with only one account type

Good to know

Rebalancing inside tax-advantaged accounts avoids realizing gains in taxable ones.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.