Asset allocation and asset location are two very important aspects of your financial plan. The goal of asset allocation is to divide your investments into different asset classes, creating a diversified portfolio that balances risk and return. On the other hand, asset location refers to the specific accounts in which you hold your investments, such as taxable, Roth, or tax-deferred. The goal of asset location is to minimize taxes and maximize after-tax returns. In my experience, many people seem familiar and comfortable with the concept of asset allocation, but few have even heard of the concept of asset location. Understanding these concepts gives you the opportunity to increase your expected returns all while reducing your tax bill at the same time.
A Deeper Dive into Asset Allocation
The goal of asset allocation is to create a diversified portfolio that balances risk and return. The process of fine-tuning this risk/reward equation is informed by several factors including your risk tolerance, your investment goals, and your time horizon. Generally speaking, someone who is in their 30s is able to take on higher levels of risk (which comes with higher expected returns) than someone in their 60s because they have more time for the market to recover from a downturn. It is really important to understand this information before creating an investment plan. This is why the first step in our QED process is the Question meeting where we work to get a deeper understanding of your situation and your goals before any further steps are taken.
A Deeper Dive into Asset Location
Asset location is a critical component of your investment strategy and can have a significant impact on your after-tax returns. Tax efficiency is the most important consideration in asset location. Some accounts are better suited to hold certain asset types. As an example, if you own a corporate bond inside a taxable brokerage account, you will receive a coupon payment that is taxed at income tax rates. It is generally preferable to hold the bond portion of your portfolio in a tax-deferred retirement account where the entire investment will be subject to income taxation, while saving your taxable brokerage account for investments that are subject to the lower capital gains tax rate. Asset location is simply creating a roadmap of tax-efficiency for your desired asset allocation. If all of this seems a little confusing, not to worry we are able to paint a clearer picture when developing your personalized investment strategy.
An Optimal Investment Strategy
Understanding both asset allocation and asset location is crucial for creating an optimal investment strategy. Looking at your risk tolerance, investment goals, and time horizon can help to build out a portfolio with the best risk-adjusted returns. Once that is created you can utilize the principles of asset location to create the most tax-efficient portfolio make-up to significantly increase your after-tax returns. Overall, asset allocation and location can work together to create an optimal investment strategy that meets your needs and helps you achieve long-term financial goals. If you need help creating this optimal investment strategy, schedule a meeting and we will work with you to create a personalized investment strategy that is tailored to your unique needs and financial situation.
This post is for educational and entertainment purposes only. Nothing should be construed as investment, tax, or legal advice.