Asset Location

Definition

Asset allocation determines what to invest in (stocks, bonds, etc.). Asset location determines where to hold those investments across account types. Optimal location minimizes tax drag on total portfolio returns.

The key insight: you want to shelter assets that generate tax-inefficient income (ordinary income, non-qualified dividends) in tax-advantaged accounts, while holding tax-efficient assets (qualified dividends, long-term gains) in taxable accounts where their favorable rates apply.

tax_drag = (taxable_return - after_tax_return) / taxable_return

Expected Impact: Proper asset location can add 0.1-0.5% annually to after-tax returns. Over 30 years at 0.3% annual benefit: $1M grows to ~$100k more than suboptimal placement.

The Simplicity Trade-off: Asset location adds complexity to portfolio management and rebalancing. For most people with under $500k in taxable accounts, the benefit is small relative to the cognitive overhead. Keep it simple until the math clearly justifies the complexity.

Core Principle

Different assets generate different types of taxable income. The optimization rule: shelter tax-inefficient assets in tax-advantaged accounts; hold tax-efficient assets in taxable accounts.

Tax-inefficient: Bonds (interest = ordinary income), REITs (non-qualified dividends), high-turnover funds
Tax-efficient: Stock index funds (low turnover, qualified dividends), municipal bonds (tax-exempt interest)

Optimal Placement Matrix

Asset Location by Account Type

Tax-Deferred (401k/IRA)

Bonds / Bond funds

REITs

High-yield bonds

Actively managed funds

Dividend-heavy stocks

Roth IRA / Roth 401k

Highest-growth assets

Small-cap stocks

Emerging markets

Growth stocks

Longest holding period

Taxable Brokerage

Total stock market index

International stock index

Tax-managed funds

Municipal bonds

I-Bonds (via Treasury)

Tax Treatment by Account

Tax-Deferred Accounts (Traditional 401k/IRA):

All growth taxed as ordinary income upon withdrawal (up to 37%)
Bonds: Interest would be ordinary income anyway — no additional penalty
REITs: Non-qualified dividends taxed at ordinary rates — optimal to shelter

Roth Accounts:

All growth is tax-free forever
Highest expected growth assets maximize value of tax-free compounding
No RMDs — assets can compound for entire lifetime

Taxable Accounts:

Long-term capital gains taxed at 0-20% (lower than ordinary income for most)
Qualified dividends taxed at LTCG rates
Foreign tax credit available for international funds
Municipal bond interest is federally tax-exempt

Foreign Tax Credit: Hold international funds in taxable accounts to claim foreign tax credit. In tax-advantaged accounts, foreign taxes paid are not recoverable.

Practical Considerations

Simplicity Trade-off: If you only have tax-advantaged accounts, hold your target allocation there. Asset location matters most when significant taxable assets exist alongside tax-advantaged accounts.

Maintain target allocation: Asset location should not change your overall stock/bond ratio
Rebalancing efficiency: Rebalance within tax-advantaged accounts to avoid triggering capital gains
Accessibility: Taxable accounts provide liquidity before age 59.5
Tax-loss harvesting: Only possible in taxable accounts — factor into strategy

Learn More

Asset location is a planning concept. Chubby simulates outcomes but doesn't prescribe allocations.