Submitted by Leamnson Capital Advisory, LLC on December 17th, 2013

281%29.jpg /%Most of us know the three most important considerations when buying real estate are: location, location, location. A much less familiar rule applies to your investments: Asset location. Managing asset location within your portfolio helps you keep as much of your wealth as possible – even after the tax man takes his cut. Given how deep that cut can be, it’s another way to add value to your overall experience as an investor.

What Does Asset Location Mean?

Asset location should not be confused with asset allocation . Though similar, there are important differences.

• Asset allocation involves dividing your money among different asset classes, based on the amount of market risk and expected return inherent to each. A simple asset allocation might be equally dividing your holdings 50/50 into stocks and bonds. You might then subdivide your stocks among international versus U.S. small-companies versus large, and so on.
• Asset location is deciding in which accounts (taxable vs. tax-sheltered) your stocks, bonds and other holdings should be placed for maximum tax efficiency.

Why Does it Matter?

There’s empirical evidence that asset location is worth doing. Financial commentator Michael Kitces points to a Morningstar analysis indicating that a well-executed asset location strategy can add as much as a half-percent to your bottom line each year.[1] That’s $500/year for every $100,000 invested. Why leave that money sitting on the table?

How an Advisor Can Help

It seems obvious that by locating your most heavily taxed investments within your tax-sheltered accounts, you can minimize or even eliminate their tax inefficiencies. But it’s harder to implement than you might think.

First, there is only so much room within your tax-sheltered accounts. After all, if there were unlimited opportunity to tax-shelter your money, we’d simply move everything there and be done with it. In reality, challenging trade-offs must be made to ensure you’re making best use of your tax-sheltered “space.”

Second, it’s not just about tax-sheltering your assets; it’s about doing so within the larger context of your overall goals. How and when you need withdraw the money helps determine the asset placement. Determining and managing the best formula for you and your unique circumstances involves many moving parts.

• Managing within the context of your bigger picture – The first step is to determine the right asset allocation based on your unique goals and risk tolerances (see Follow These Five Steps to a Better Investment Experience ). Only then is it appropriate to determine where those holdings should reside for tax efficiency. 
• Planning for your goals and timeframe – Is retirement near or far? Do you want to leave a legacy? Are your circumstances likely to change in the next few years? There may be withdrawal, estate planning or other needs that override optimal asset location.
• Managing tax-sheltered accounts – What are the tax-sheltered account opportunities: Roth versus traditional IRAs versus company retirement plans? How much room do you have in each for holding assets? Which types of holdings in which kinds of accounts are going to give you the most tax-efficient bang for your buck? How does the ever changing tax code impact your plans?
• Considering other tax-planning needs – We also consider the benefits of holding stocks within taxable accounts. That includes the ability to harvest capital losses against capital gains (see Three More Ways to Reduce Your 2013 Taxes ), donate appreciated shares to charity (see Reduce Your Taxes While Benefiting the Community ), implement a step-up in basis, and take foreign tax credits. While these opportunities have more or less importance depending on your goals and circumstances, they become unavailable for stocks held in tax-sheltered accounts.

Why You’ve Likely Never Heard of Asset Location.

We rarely see asset location covered in the financial press. Why? In part, we think it’s because a large swath of the financial industry ignores the need. You’ll typically only see asset location planning offered by an advisor (like Leamnson Capital), who is well-positioned to provide objective counsel and oversight for your larger holdings. In the absence of this oversight, you’ll find:

• Missing Pieces – Asset location is best implemented when you and your advisor consider your total wealth and its multiple, often competing components. As you accumulate regular accounts, retirement plan accounts and financial service providers, your assets can wander far and wide over the years. It’s a challenge to organize them into a cohesive whole, especially when there is no “quarter back” advisor in place to oversee the results.
• Missing Expertise – Even if you have a handle on your varied accounts and holdings, asset location does not lend itself to a turnkey formula. There are essential guidelines, as touched on above, but it’s both an art and a science to best apply asset location within your unique, often complex wealth management needs.
• Missing Oversight – Asset location is not a set-and-forget activity. As your own goals, the market and government regulations change, your portfolio requires ongoing coordination to retain the desired efficiencies.

While you may not have heard of the benefits of effective asset location, the resulting money you may unnecessarily lose to taxes can be very real. Is your advisor discussing asset location with you? If not, there are plenty of good firms, like ours, who will. Can we answer additional questions? Let us know!

[1] Michael Kitces, “Asset Location: The New Wealth Management Value-Add For Optimal Portfolio Design,” March 6, 2013; and Morningstar Tries to Quantify The Value of Financial Planning,” November 12, 2012.