Leveraging Tax-Advantaged Investments: Why Asset Location Matters

Authored by: Chris Vidler, CFP®, CIMA®

As your income rises and your savings grow, your investment portfolio often becomes more complex. What may have started as a single workplace retirement account can expand to include an IRA, Roth account, taxable brokerage account, equity compensation, deferred compensation, and accounts held by your spouse.

These accounts generally fall into three broad tax categories. A taxable brokerage account allows you to buy and sell investments, but dividends and realized capital gains may create taxes along the way. Tax-deferred accounts, including many traditional 401(k)s and IRAs, generally postpone taxes on investment earnings until money is withdrawn. Roth accounts are funded with after-tax dollars and may provide tax-free qualified withdrawals.

Because these accounts are taxed differently, the same investment may have a different after-tax impact depending on where it is held.

Investment planning often focuses on asset allocation—how much of your portfolio is invested in stocks, bonds, real estate, and other asset classes. Asset allocation is important, but it is only part of the picture.

Asset location considers where those investments are held across taxable, tax-deferred, and Roth accounts. When these accounts are coordinated, asset location may help manage annual tax exposure and provide greater flexibility as your financial needs change.

Asset Allocation Versus Asset Location

Asset allocation and asset location sound similar, but they address different decisions.

Asset allocation determines the overall mix of investments in your portfolio. It is generally based on factors such as your time horizon, income needs, financial objectives, and comfort with market fluctuations.

Asset location determines which accounts hold those investments.

Tax-aware investing adds another consideration: how an investment generates taxable income. Some investments distribute more interest, ordinary income, dividends, or capital gains than others. These investments are sometimes described as less tax-efficient when held in a taxable account.

Examples may include taxable bond funds, real estate investment trusts, and funds with higher portfolio turnover. That does not make them poor investments. It simply means their tax characteristics may deserve additional attention when deciding where they fit within the household portfolio. The glossary’s definitions of dividends, capital gains, and ordinary income provide the foundation for this distinction.

For example, two households could own the same overall mix of stocks and bonds. However, one household might hold its bonds primarily in a tax-deferred retirement account while keeping tax-aware equity investments in a taxable brokerage account. The other household might hold the same investments in different locations.

Their overall asset allocations may look identical, but their annual tax experiences could be different.

View the Portfolio at the Household Level

Asset location is generally most useful when viewed across the entire household rather than account by account.

Suppose one spouse’s workplace retirement plan offers an appropriate bond fund, while the household’s taxable brokerage account provides a wider range of equity investments. Rather than holding the same stock-and-bond mix in both accounts, the household might hold more of its bond allocation inside the retirement plan and more of its equity allocation in the taxable account.

The appropriate arrangement would depend on a variety of factors. The important point is that the household’s overall asset allocation could remain the same even though the individual accounts look very different.

This can become increasingly relevant as accounts accumulate over time. A household may have a current 401(k), an old employer plan, several brokerage accounts, equity compensation, and retirement accounts owned by both spouses. Looking at each account separately can make the portfolio feel fragmented. A household-level approach instead considers how the accounts work together.

Changes also do not always need to happen at once. Existing gains, account restrictions, and tax considerations may make a gradual transition more practical. New contributions, dividends, withdrawals, and rebalancing can all be used to adjust the portfolio over time.

Where Direct Indexing May Fit

Direct indexing is one example of a more advanced tax-aware investment strategy. Instead of owning a mutual fund or exchange-traded fund that tracks an index, the investor directly owns many of the individual securities intended to approximate that index. This structure may provide more opportunities to sell individual positions that have declined while maintaining broader market exposure.

Those realized losses may be used to offset certain realized gains, subject to applicable tax rules.

Direct indexing may also provide additional control when managing concentrated stock, charitable gifts, or portfolio restrictions. However, it introduces additional complexity. The portfolio may perform differently from the index it seeks to track, and trading activity must be coordinated with other household accounts to address potential wash-sale concerns.

Fees, account size, embedded gains, and the availability of losses also affect the usefulness of the strategy. Direct indexing may be worth evaluating for some taxable portfolios for investors in high income tax brackets, but it is not necessary or appropriate for every investor.

Do Not Let Taxes Make Every Investment Decision

Taxes are an important part of investing, particularly as income and portfolio values increase. But they should not become the only factor driving the portfolio. An investment may be tax-efficient but still be a poor fit if it creates too much concentration, limits liquidity, adds unnecessary cost, or does not align with the investor’s risk tolerance.

The opposite can also be true. Avoiding a tax consequence at all costs may cause an investor to hold an outdated or overly concentrated position for too long. A lower tax bill does not necessarily mean a better financial outcome.

Tax-aware investing works best when it supports the broader financial plan. Investment objectives, cash-flow needs, time horizon, estate planning, charitable intentions, and future withdrawals should all be considered alongside taxes.

A More Coordinated Approach

As a portfolio grows, the relationship among taxable, tax-deferred, and Roth accounts becomes increasingly important.

Asset allocation determines what you own. Asset location considers where you own it.

Coordinating those decisions may help create a more thoughtful investment structure and provide greater flexibility as your income, career, and financial priorities change.

At Concentric Wealth Partners, we help clients evaluate how their investments, workplace benefits, taxes, and long-term financial plans fit together. To discuss how asset location may relate to your broader financial picture, contact our team.

Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax or legal issues, these matters should be discussed with the appropriate professional.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Chris Vidler and not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.