Asset Location

Asset Location

Asset Location

An additional way that a passive advisor can add value is not just asset allocation but asset location, as shown in the painting below.

The overarching purpose of such a strategy is to optimize after-tax returns. Specifically, for a client that has a mixture of taxable accounts -- along with traditional IRAs and Roth IRAs -- it is often helpful to construct a single portfolio consisting of multiple asset classes that are divided up among the different accounts. 

Considerations in deciding which asset classes to place in different account types include the following:

1. For Roth IRAs where all the investment growth is tax-free, the preference is to put in the asset classes that have the highest expected returns, which is equivalent to combining those with the highest risks. Examples include emerging markets and international small value.

2. For traditional IRAs where current dividends are tax deferred until withdrawal and future withdrawals are taxed as ordinary income (highest tax rate), the best strategy is to include the asset classes that have high dividends and low expected returns. Examples include fixed income, (with lower expected returns and high current tax dividends), and real estate investment trusts (REITs), with relatively high dividend payouts.

3. For taxable accounts, the best strategy utilizes higher expected return and tax-managed funds whenever possible. Remember that when you sell in a taxable account, the tax treatment is better than the IRA, because long-term capital gains tax is generally less than ordinary income tax rates. Examples include tax-managed funds for U.S. large company, U.S. large cap value, U.S. small blend, U.S. small cap value, and international value and emerging markets.

It is important for clients to understand that in an asset located or tax-hybrid portfolio, each of the accounts will have very different performance. If the client is not comfortable with this performance difference (e.g., a married couple where the wife's Roth IRA has a higher expected return than the husband's traditional IRA), then the tax-hybrid portfolio structure may not be appropriate.

Furthermore, a good passive advisor will evaluate the purpose of each account to determine if it should be stand-alone or part of a hybrid structure. A special needs trust for a disabled child is an example of an account that should be its own portfolio.

Establishing an asset located or tax-hybrid investment plan isn't a matter of one hat proving to be a good fit for everyone. In some cases, an individual's tax situation might wind up creating better after-tax results by putting funds into different types of stock or bond asset classes, or further diversification away from Roths and traditional IRAs. 

At IFA, our advisors work with each client to consider potential investment ramifications relating to issues that could increase personal tax liabilities and make funds less desirable in a taxable account. Advisors working on behalf of investors they serve can also tap into our in-house expertise offered through IFA's wholly owned subsidiary, IFA Taxes. 

No matter what type of unique situation investors find themselves in relating to taxes, going through an objective and fact-based assessment of the best locations for different funds arguably is one of those exercises that should be checked off before investing in a globally diversified and passively managed portfolio. 

For investors who actually find savings from a broad-based asset location review, though, this represents only a slice of the task involved in developing a more tax-efficient portfolio. Part and parcel with such a strategy is maintaining and rebalancing the portfolio through all types of markets.

Also important to take into account as part of any robust and long-term asset location process is to keep in-mind an investor's cash needs. For example, if an IFA client has a cash need from a taxable account, confining the sell trades to a single account may throw the portfolio out of balance.

As a tax-conscious fiduciary, IFA's wealth management process takes into consideration how to trade all of a client's accounts in unison with an eye towards tax-efficiency, minimization of transaction costs and maintenance of each investor's designated asset allocation in-line with results from a person's Risk Capacity Survey. 


This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful.  Investing involves risks, including possible loss of principal. IFA Index Portfolios are recommended based on time horizon and risk tolerance. Take the IFA Risk Capacity Survey (www.ifa.com/survey) to determine which portfolio captures the right mix of stock and bond funds best suited to you.  Allocations and holdings are subject to change.  Please see ifa.com for more details on the construction and historical data of IFA Index Portfolios.  See ifabt.com for backtested info and disclosures.  This article is intended to be informational in nature and should not be construed as tax advice. IFA Taxes does not provide auditing or attestation services and therefore is not a licensed CPA firm.