investing

The Stock-Bond Shuffle of Asset Location

It's a well-used strategy to help minimize taxes. Take a look at how it works.

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.

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 Bonds are better in a pre-tax traditional IRA, where gains are effectively taxed at income rates when they are withdrawn.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?

About the Author

David John Marotta, CFP®, AAMS®, AIF®

President, Marotta Wealth Management

David John Marotta is the president of Marotta Wealth Management. David earned a master's degree in computer science from the University of Oregon and a B.A. in philosophy and electrical engineering from Stanford University.

Most Popular

Tax Wrinkles for Work-at-Home Employees During COVID-19
taxes

Tax Wrinkles for Work-at-Home Employees During COVID-19

Are your home office expenses deductible? How does going out of state to work for a while affect your tax picture? There are some interesting wrinkles…
November 9, 2020
Retirement: It All Starts with a Budget
personal finance

Retirement: It All Starts with a Budget

When you’re meeting with your financial planner, do you talk about your budget? If not, you should.
November 10, 2020
Will Joe Biden Raise YOUR Taxes?
taxes

Will Joe Biden Raise YOUR Taxes?

During the campaign, Joe Biden promised that he would raise taxes for some people. Will you be one of them?
November 10, 2020

Recommended

Your Guide to Roth Conversions
Tax Breaks

Your Guide to Roth Conversions

Like marriage, converting a traditional IRA to a Roth is not a step that should be taken lightly.
November 24, 2020
10 States with the Highest Gas Taxes
taxes

10 States with the Highest Gas Taxes

COVID-19 has made us appreciate driving our cars more, but filling up the tank will cost you more in these state.
November 23, 2020
10 States With the Lowest Gas Taxes
taxes

10 States With the Lowest Gas Taxes

Saving money is a marathon not a sprint. And even low gas taxes can help keep money in your pocket.
November 21, 2020
Election 2020: States With Tax Questions on the Ballot
Politics

Election 2020: States With Tax Questions on the Ballot

On November 3, voters in 17 states weighed in on a variety of proposed changes impacting taxes on everything from property to pot.
November 19, 2020