Understanding Asset Location: Where You Invest Matters

The assets you invest in are crucial, but where you keep them carries nearly as much weight. Various account types have different tax implications and consequences on your portfolio. Strategically placing investments across different accounts, known as asset location, can be an effective way to manage these effects and balance their benefits.

In this article, we’ll break down how asset location works, how it differs from asset allocation, and which types of accounts typically suit different investments. You’ll learn when this strategy should be a priority and how a financial advisor can help you implement it effectively. We’ve also gathered insights from financial professionals to provide a deeper understanding of this topic.

Understanding Asset Location

Asset location is a tax-efficient investing strategy that focuses on where you hold different types of investments across taxable, tax-deferred, and tax-free accounts. Each account type comes with distinct tax treatments that can either erode or enhance your after-tax returns. By placing certain investments in the most tax-advantaged accounts, you can help improve long-term portfolio efficiency without changing your overall asset allocation.

For example, you may decide to place long-term, high-growth securities, such as equities, in a tax-free account, like a Roth IRA, where future gains aren’t subject to taxes. Conversely, income-generating assets like real estate investment trusts (REITs) or bonds may be optimal in tax-deferred accounts, like a traditional IRA, where annual income doesn’t face taxes until withdrawal.

Dr. Stephan Shipe, Ph.D., CFA, CFP^®, founder of Scholar Financial Advising, explains that “optimizing for asset location can add roughly 20 basis points of return annually.” While that may sound modest, he notes it can have a “meaningful impact—especially in long-term, compounding portfolios.”

Integrating asset location into your investment approach allows you to gain more control over the tax outcomes on your portfolio. This can help you either minimize your tax burden or manage it, especially in retirement, during which you’ll typically begin drawing assets with longer holding periods.

Asset Location vs. Asset Allocation

Asset allocation and asset location are related but distinct strategies. The former prioritizes how you spread your investments across different asset classes, such as equities, fixed income, and cash equivalents, to manage risk and optimize returns. This strategy helps ensure you avoid overexposure to any one type of investment.

Asset location, on the other hand, focuses on dividing your assets among taxable, tax-deferred, and tax-free accounts to reduce the impact of taxes on your overall returns. Efficient tax strategy, therefore, is the primary goal here.

When combined, asset allocation and asset location are complementary. The strategies can help you maximize performance and tax efficiency, strengthening your portfolio over time.

Types of Asset Locations

There are three primary types of investment accounts where you would hold your assets: taxable, tax-deferred, and tax-free. They each come with tax benefits and implications that dictate which types of assets are most beneficial to keep within them. Below is a breakdown of each:

Taxable

These include individual or joint brokerage accounts. Within them, you may invest in a wide range of securities, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs). They require you to pay taxes on interest, dividends, and realized capital gains.

Tax-Deferred

Tax-deferred accounts, such as a traditional 401(k) or IRA, allow you to contribute pre-tax dollars and grow them tax-deferred. When you withdraw upon retirement age, you must pay ordinary income taxes. Unlike a taxable account, you don’t need to pay additional taxes for capital gains.

Tax-Free

Roth IRAs and Roth 401(k)s allow you to contribute after-tax dollars, but your investments grow tax-free. So, when you take distributions, you won’t owe any additional taxes.

When to Prioritize Asset Location

Asset location can be a helpful strategy, but some should prioritize it more than others. If your portfolio is small or falls entirely under one account type, optimizing for tax efficiency may not make sense. However, as your wealth grows and you diversify across asset classes, it may be beneficial to distribute your assets across various accounts for tax efficiency.

According to Shipe, focusing on asset location is helpful but only when you’ve achieved a certain level of diversification. “First, you need the right mix of investments. Once that’s in place, location is a valuable layer of optimization that all investors can benefit from,” he highlights.

You might consider an asset location strategy when:

• You hold both tax-advantaged and taxable accounts.
• Your investments generate significant taxable income.
• You’re in a higher tax bracket now or expect to be in retirement.
• You want to maximize after-tax returns without changing your overall risk profile.

Asset location can also be a pertinent approach to retirement planning, sometimes known as tax diversification. Withdrawing from accounts in a strategic order can help extend your time horizon and reduce your tax burden.

Mistakes to Avoid

As you commit to an asset location strategy, it’s vital to avoid common mistakes that may have lasting negative consequences. This includes failing to consider the concept altogether, as well as allocating assets improperly.

Shipe cautions that a crucial mistake is underestimating the potential size of your taxable brokerage account. “IRAs don’t carry ongoing tax implications, but brokerage accounts do—and if they’re not structured thoughtfully, it can be difficult and expensive to unwind those tax consequences down the road,” he says.

Another error, according to Chad Gammon, CFP^®, owner of Custom Fit Financial, is when all the accounts in your portfolio “look the same.” In other words, keeping identical types of assets in each account defeats the purpose of the strategy altogether. Certain investment types, such as equities, trend better to tax-free accounts than taxable or tax-deferred ones. Conversely, fixed-income securities may be more beneficial in tax-deferred or taxable accounts.

How a Financial Advisor Can Help Optimize Asset Location

While beneficial, asset location is a nuanced strategy that may require the expertise of a financial advisor. A professional can help implement it across your accounts and ensure you’re maintaining the proper assets in each one. They can also leverage their experience to avoid mistakes, such as those noted above.

More specifically, we recommend finding a fiduciary advisor or investment manager to assist you. This includes individuals with reputable titles, like Certified Financial Planner (CFP) or Chartered Financial Consultant (ChFC), who must put your best interest first at all times.

If you need help in your search for a financial advisor, we recommend using this free matching tool. After a brief quiz regarding your goals, investor profile, and current situation, it’ll pair you with a vetted expert who suits your needs and lifestyle.

Frequently Asked Questions

How much does asset location matter?

Asset location, as Shipe explains, is an aspect of investing that may generate marginal returns per year but can compound over time. Additionally, the strategy can pay off in retirement, resulting in more tax-efficient withdrawals. For example, keeping high-growth assets in a Roth IRA rather than a taxable brokerage can help you avoid unnecessary capital gains taxes.

Is asset location only important for high-net-worth investors?

While focusing on asset location is useful for those with complex and large portfolios, it can still be helpful for moderate investors. We recommend speaking with a financial advisor to determine if the strategy is the right fit for you. They can underline how it aligns with your retirement withdrawal strategy, which it may impact directly when put into action.

How often should I review my asset location strategy?

As with any aspect of your portfolio, an annual review is a wise way to monitor your progress and rebalance if necessary. If possible, evaluating your strategy with a financial advisor can help you know if you’re on the right track and if any adjustments might optimize your plan.