Asset location is placing specific securities in specific types of accounts to maximize after-tax returns. This strategy can boost after-tax returns by as much as 1%. When we rebalance a client’s portfolio, we rebalance all of their accounts’ holdings aggregated together. This means each trade is an opportunity to optimize which holdings are in each account type.
SEE ALSO: 10 Timeless Investing Principles
Imagine a client who is taking monthly withdrawals from their taxable brokerage account. This account may be filled with highly appreciated stock positions and less appreciated bond positions. All other things being equal, it would be best to sell the bond positions and delay selling the appreciated stock positions.
But imagine that after months of selling bonds, the client’s account has gotten out of balance. They need more bonds and less stocks in their portfolio overall.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
One trading technique would be to sell the bonds in the taxable account — because this avoids paying tax on the larger unrealized gains on the stock positions — and also sell stock in an IRA, where there are no gains tax consequences. Then, with the cash generated in the IRA, we can buy bonds to move toward the target allocations.
Oddly, this technique might involve selling a bond position in the taxable account for a small capital gain, and buying that exact same position in an IRA in order to keep the portfolio in balance. Although this type of trading can trigger wash sales if you are selling for a loss, selling for a gain creates no such complexity.
As we do these types of odd trading techniques on a daily basis sometimes, we’ve developed nicknames for the various strategies. My favorite nickname for this strategy is “the stock-bond shuffle.” In reality, the stock-bond shuffle can be used anytime you want to move a holding from one type of account to another.
See Also: Shelter from the Storm: Safe, 'Boring' Financial Products Are Exciting Today
Imagine a client who just completed a Roth contribution and needs to buy bonds. Buying bonds in a Roth account sometimes needs to be done, but it is better to have your more volatile securities with higher returns under the tax-free shelter of the Roth IRA. Bonds are better in a pre-tax traditional IRA, where gains are effectively taxed at income rates when they are withdrawn.
The stock-bond shuffle can then be used to sell some stocks in the IRA and buy those exact same stocks in the Roth IRA. Then, with the new money in the IRA we can purchase the bonds we wanted from the start.
This stock-bond shuffle can be confusing to clients, as it is hard to see through the weeds of the trading notifications in order to see the advantages of the larger asset location strategy. However, this fairly common trading strategy makes a small change in your annual tax bill, and it is small changes such as these which have large effects over time.
See Also: Is Now a Good Time to Invest?
-
Is 100 the New 70?Eating well, exercising, getting plenty of sleep and managing chronic stress can help make you a SuperAger. Funding that long life requires longevity literacy.
-
Nine Lessons to Be Learned From the Hilton Family Trust ContestDisclaimers, good communication, post-marital agreements and more could help avoid conflict in a family after the owners of a wealthy estate pass away.
-
Is 100 the New 70?
Eating well, exercising, getting plenty of sleep and managing chronic stress can help make you a SuperAger. Funding that long life requires longevity literacy.
-
Nine Lessons to Be Learned From the Hilton Family Trust Contest
Disclaimers, good communication, post-marital agreements and more could help avoid conflict in a family after the owners of a wealthy estate pass away.
-
Strategies to Optimize Your Social Security BenefitsTo maximize what you can collect, it’s crucial to know when you can file, how delaying filing affects your checks and the income limit if you’re still working.
-
Don’t Forget to Update Beneficiaries After a Gray DivorceSome states automatically revoke a former spouse as a beneficiary on some accounts. Waivers can be used, too. Best not to leave it up to your state, though.
-
What’s the Difference Between a CPA and a Tax Planner?CPAs do the important number crunching for tax preparation and filing, but tax planners look at the big picture and come up with tax-saving strategies.
-
Charitable Remainder Trust: The Stretch IRA AlternativeThe SECURE Act killed the stretch IRA, but a properly constructed charitable remainder trust can deliver similar benefits, with some caveats.
-
Three Ways to Take Control of Your Money During Financial Literacy MonthBudgeting, building an emergency fund and taking advantage of a multitude of workplace benefits can get you on track and keep you there.
-
How Did O.J. Simpson Avoid Paying the Brown and Goldman Families?And now that he’s died, will the families of Nicole Brown Simpson and Ron Goldman be able to collect on the 1997 civil judgment?
