Asset Location Strategy: How to Boost Returns by 0.75% Without Taking More Risk
Asset Location Strategy: How to Boost Returns by 0.75% Without Taking More Risk
COACHING POINTS
- The Distinction: Asset Allocation is deciding to hold 60% Stocks and 40% Bonds. Asset Location is deciding to put the Stocks in your Brokerage account and the Bonds in your IRA. Most investors ignore the latter and pay the price.
- The Hierarchy: Not all assets are taxed equally. Bonds and REITs trigger heavy “Ordinary Income” taxes (up to 37%). Stocks trigger lower “Capital Gains” taxes (20%). High-growth assets belong in Roths; Tax-inefficient assets belong in IRAs.
- The Free Lunch: Correctly locating assets reduces “Tax Drag.” Studies show this adds approximately 75 basis points (0.75%) to your annual after-tax return. Over 30 years, this can equal hundreds of thousands of dollars in extra wealth.
You spend hours agonizing over which ETF to buy, but zero minutes thinking about which account holds it.
This is a mistake. Putting a high-yield bond fund in a taxable brokerage account is like running the heat with the windows open. You are voluntarily giving your returns to the IRS.
Asset Location is the easiest money you will ever make because it requires zero market prediction.
Source: Vanguard Research / Morningstar
Why holding Bonds in a Taxable Account is expensive.
- Asset: Corporate Bond Fund yielding 6%.
- Scenario A (Taxable Account):
Yield: 6.0%.
Tax Bill (37% Fed + 5% State): -2.52%.
After-Tax Return: 3.48%. - Scenario B (Traditional IRA):
Yield: 6.0%.
Tax Bill: $0 (Deferred).
Net Return: 6.0%. - Impact: You lose over 40% of your income simply by parking the asset in the wrong garage.
What-If Scenario: $1M Portfolio (50/50 Split)
Comparison: “Mirroring” (Lazy) vs. “Optimizing” (Smart).
| Strategy | Taxable Acct Holds | IRA Holds | Est. 20-Year Tax Drag |
|---|---|---|---|
| Lazy Mirroring | 50% Stocks / 50% Bonds | 50% Stocks / 50% Bonds | High (Bonds taxed annually) |
| Asset Location | 100% Stocks (Tax Efficient) | 100% Bonds (Tax Shelter) | Low (Tax deferred) |
Result: The optimized portfolio ends up with ~$150,000 more wealth because tax-inefficient yields were shielded inside the IRA.
Visualizing the Tax Drag on Income
| Account Location (for 6% Bond) | Net After-Tax Return (%) | Lost to Taxes (%) |
|---|---|---|
| Taxable Brokerage | 3.5 | 2.5 |
| Traditional / Roth IRA | 6.0 | 0.0 |
*The red portion represents the “Voluntary Tax” you pay by holding bonds in the wrong account. Asset Location eliminates this drag.
Execution Protocol
Print out statements for your Taxable, IRA, and Roth accounts. Identify “Tax-Inefficient” assets (REITs, Bond Funds, Actively Managed Funds with high turnover) currently sitting in your Taxable account.
Put your highest expected return assets (e.g., Nasdaq-100, Small Cap Value) in your Roth IRA. Since Roth withdrawals are tax-free, you want the account with the biggest gains to be the one the IRS can’t touch.
Fill your Taxable Brokerage with broad market Index ETFs (e.g., VTI, VOO). They rarely pay capital gains distributions and qualify for lower long-term tax rates. If you need bonds here, use Municipal Bonds (MUB).
COACHING DIRECTIVE
- Do This: If you have assets spread across multiple account types (Taxable, Pre-Tax, Roth). This is essential hygiene for net worth over $500k.
- Avoid This: If all your money is in one bucket (e.g., 100% in 401k). You can’t practice asset location if you only have one location. Start a Roth or Taxable account to diversify tax risk.
Frequently Asked Questions
What is Asset Location?
Asset Location is the strategy of placing specific investments into specific account types (Taxable, Tax-Deferred, Tax-Free) to minimize the total tax burden on the portfolio.
Why put stocks in a Taxable account?
Stocks held for over a year are taxed at preferential Long-Term Capital Gains rates (0%, 15%, or 20%), which are lower than income tax rates. Also, you can use ‘Tax Loss Harvesting’ with stocks in a taxable account.
Should I put Bonds in a Roth IRA?
Generally, no. Roth IRAs are precious ‘Tax-Free Forever’ space. You don’t want to waste that space on low-growth assets like bonds. Use the Roth for assets that will double or triple in value.