Suzanne Stepan, CFA®, CFP®

Vice President, Senior Wealth Management Advisor

Asset Location, Location, Location!

Often in real estate we hear the mantra: location, location, location. The repeated statement suggests value varies based on the location in which the real estate resides. A similar phenomenon occurs in investing and is referred to as Asset Location. The placement or location of your investments can ultimately provide tax-efficiency and enhanced after-tax returns while preserving a stated level of risk.

There are three main types of accounts to locate or “house” investments:

Taxable: an investment account where taxes will be owed each year on interest, dividends and realized capital gains (e.g. Individual, Joint, Trust, etc.).

Tax-deferred: an investment account where the investor typically invests pre-tax dollars and investment earnings from interest, dividends and capital gains grow tax-free generally until retirement at age 59 ½ or older when upon withdrawal, taxes are owed (e.g. Traditional IRA, 401(k), 403(b), etc.).

Tax-exempt: an investment account where the owner typically invests after-tax dollars and investment earnings from interest, dividends and capital gains grow tax-free and are withdrawn tax-free generally after age 59 ½ (e.g. Roth IRA, Roth 401(k), etc.).

Utilizing the investment strategy of asset location with varying tax-profiled accounts can maximize after-tax returns. The goal is to “house” or locate the least tax-efficient assets in the accounts that have the most favorable taxation and “house” or locate the most tax-efficient assets in the accounts that are taxed with the least favorable outcomes. This is done while maintaining the desired asset allocation and risk tolerance in aggregate.

How does it work?

First, in order to create a sound financial plan, a client’s goals and objectives must be established. An investment objective/risk tolerance is then determined to achieve the goals. The investment objective is utilized by the investment manager in determining the optimal investment strategy and an appropriate asset allocation to achieve the client’s overarching goals. Further, based on the types of accounts available to “house” the investments, asset location may be utilized. Each asset’s tax characteristics are analyzed and “housed” in the account to best optimize the after-tax performance of the consolidated portfolio. This strategy maintains the asset allocation in aggregate, but not on an individual account basis.

By way of illustration:

Just as baseball is a team sport, your assets are viewed as a team working together. The coach’s decisions on where to place each player on the field can affect the outcome of the game. Asset location works similarly. Certain asset classes benefit more than others based on their placement and which type of account they are “housed.” Based on each asset class’ characteristics, enhanced after-tax returns can be achieved in tax-efficient accounts. While all the asset classes work together in a diversified portfolio, placement is important for enhanced wealth creation. As different baseball players have certain strengths and weaknesses based on where they are placed on the field, the type of account chosen for your investment can make a difference in the amount of after-tax earnings. This is due to investments being subject to different tax rules and accounts having different tax treatments.

Much like analyzing the talent on the baseball field, here at Greenleaf Trust, we evaluate each of the “players” in our investment portfolio to determine their correct placement in the most favorable tax “house” to achieve each of our clients’ goals and objectives.