The Art of Asset Location

Location, location, location—a rule of thumb in real estate has applications in the financial planning world too. With expected returns for fixed income higher than in years past, proper asset location is as relevant as it’s ever been.

So, what do we mean by “asset location”? In essence, it means placing investment types (stocks and bonds) within account types (taxable, IRAs, Roths) to reduce the drag taxes can have on your investment returns over time. The concept is simple, though the execution can be complicated.

How Does Asset Location Work?

The principle is straightforward: Locate less tax-efficient investments in IRAs and Roths and more tax-efficient ones in taxable accounts. You have flexibility in where you place low-return investments since there’s lower tax liability when you sell the position or while you hold the position.

If we were to oversimplify the art of asset location, it might go like this: Bonds should be held in tax-deferred accounts, and stocks in taxable ones. That’s because stocks are typically taxed at lower long-term capital gains rates, while the income from bonds faces higher ordinary income rates (municipal bonds can be a notable exception here due to their favorable federal or state tax treatment). 

Four Asset Location Scenarios

Typically, the following four contexts are where you’ll see the greatest advantage when implementing an asset location strategy:

1. You’re in a high tax bracket (32% and up). The higher your current tax rate, the bigger the potential benefits of proper asset location.

2. You have or expect to have substantial assets in all three tax categories: taxable, IRAs (tax-deferred) and Roths (tax-free).

3. You invest substantially in fixed income. Generally, the more you invest in bonds and fixed-income securities, the more you can benefit from asset location.

4. You expect to have a large difference between your current and future tax brackets.

A last thought to consider: The tax tail shouldn’t wag the investment dog. In other words, if carrying out an asset location strategy will result in a large tax bill and negate the benefits of the exercise, we won’t recommend it. For example, selling highly appreciated assets inside of a taxable account just to move those assets to their “proper” location could cost you as much or more in taxes than it would save.

Likewise, always consider the psychological or emotional impact of your asset location strategy. Despite the potential benefits of keeping volatile stocks in taxable accounts, you might feel more comfortable locating them in retirement accounts, where you are taking withdrawals over a longer period of time. Similarly, you may want to keep cash and bonds in taxable accounts that can provide a liquidity cushion in the event of unexpected expenses.

Asset location isn’t right for everybody, and your tax mileage will vary depending on your individual situation. But with the passage of the One Big Beautiful Bill Act and the opportunities it presents for tax savings, having a conversation about asset location now could help you enhance your long-term financial plan.