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 Bonds are better in a pre-tax traditional IRA, where gains are effectively taxed at income rates when they are withdrawn.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

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
10 States With the Highest Sales Taxes
Tax Breaks

10 States With the Highest Sales Taxes

Before you embark on a shopping spree in any of the 10 worst states for sales taxes, make extra room in your budget.
June 16, 2021
12 Housing Stocks to Ride the Red-Hot Market
investing

12 Housing Stocks to Ride the Red-Hot Market

The U.S. has a housing shortage and a love affair with home improvement, both of which could create tailwinds for this group of housing stocks.
June 8, 2021

Recommended

2021 Child Tax Credit Calculator
Tax Breaks

2021 Child Tax Credit Calculator

Find out how much money you'll get each month under the child tax credit rules for 2021. Payments will start July 15.
June 18, 2021
18 States With Scary Death Taxes
inheritance

18 States With Scary Death Taxes

Federal estate taxes are no longer a problem for all but the extremely wealthy, but several states have their own estate taxes and inheritance taxes t…
June 17, 2021
Taxes on Unemployment Benefits: A State-by-State Guide
state tax

Taxes on Unemployment Benefits: A State-by-State Guide

Don't be surprised by an unexpected state tax bill on your unemployment benefits. Know where unemployment compensation is taxable and where it isn't.
June 17, 2021
The 10 Least Tax-Friendly States for Middle-Class Families
state tax

The 10 Least Tax-Friendly States for Middle-Class Families

Failing to consider state and local taxes before moving your family to another state could cost you thousands of dollars each year.
June 17, 2021