How you divide your assets between taxable and tax-deferred (i.e. Traditional IRA, 401k) or tax advantaged accounts (i.e. Roth IRA) 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 towards your investment goals. Taking the time to place the right assets in the right place can boost your portfolio returns by paying less taxes and allowing your money more time for compounding earnings .
Generally investors should put as much of their investments as possible in their tax advantaged accounts such as a Roth or Traditional IRA or 401k account to gain the tax advantages these accounts offer. But if you are lucky enough to have enough money that you need to divide your assets between taxable accounts and tax advantaged accounts you will want to obtain the maximum benefit available from careful placement.
When dividing assets between taxable and tax deferred or advantaged accounts, generally you want to put items with high tax rates in your tax deferred or tax advantaged accounts.
Ideal investments for tax deferred and tax advantaged accounts: Taxable bonds, commodity funds, REITS (Real Estate Investment Trusts), Individual TIPs (Treasury Inflation Protected Bonds), and individual stocks that pay a large dividend. These investments may face unfavorable tax treatment in a taxable account and therefore are better suited for tax advantaged accounts. If you actively trade stocks (not recommended) it may be beneficial to do so in an IRA to avoid short-term capital gains, which are taxed at ordinary income tax rates.
Ideal investments for taxable accounts: Individual stocks that pay no dividend, or a small dividend, index stock funds and ETFs, tax managed funds, and any tax-free investments such as municipal bonds and funds.
Ideally you would want to hold taxable account assets for longer than 1 year to be eligible for long term capital gains treatment. Investment assets eligible for long term capital gains or are tax-free should be held in taxable accounts.
The details may seem trivial, but where an asset is placed can make a significant difference in the net amount your investments are worth. Paying fewer taxes and allowing years of compounding to work in your favor can really increase your net investment returns.
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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