Arbor Asset Allocation Model Portfolio (AAAMP) Blog

AIP Money Management Tips

After you have funded 6-12 months of living expenses in a liquid emergency fund, tax-deferred accounts such as IRAs and 401(k)s are a great way to build long term wealth. Until you have reached the limits of these investment vehicles; all your investment funds should go into tax deferred vehicles. The only question is which kind of IRA? (See www.blog.ArborInvestmentPlanner.com/2010/01/traditional-ira-roth-ira-or-both)  But what if you have funded your emergency fund, and maxed out your 401(k) and IRA opportunities? How do divide your assets between taxable and tax-deferred accounts?

When dividing assets between taxable and tax-deferred accounts; generally you want to put items with high tax rates in your tax deferred vehicle.  Taxable bonds, commodity funds, REITS (Real Estate Investment Trusts), and Individual TIPs (Treasury Inflation Protected Bonds) should be allocated to your IRA or 401k. If you actively trade stocks (not recommended) it may be advantageous to do so in an IRA to avoid short-term capital gains, which are taxed at ordinary income tax rates.

Investment assets eligible for long term capital gains or that are tax-free should be held in taxable accounts. Individual stocks, index stock funds and ETFs, municipal bonds and funds, and tax managed funds are all good candidates for taxable accounts. Tax-free investments should not be put into a tax-deferred account.

How you divide your assets between taxable and non-taxable accounts is an important consideration that can have a profound effect on your net investment returns. Only what you have left, net after taxes, can be used in your retirement. Taking the time to place the right assets in the right place can boost your portfolio returns by allowing your money more time to compound and by paying fewer taxes.