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Asset location basics

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Katie Attebery

Most people have been told "asset allocation" — the mix of different asset classes, such as stocks, bonds, and cash — is one of the most important tenets of portfolio management. However, many people are not as familiar with the concept of "asset location" — where these different types of assets reside in the various accounts that make up a portfolio.

Asset classes can be mapped on a tax efficiency spectrum from least tax efficient to most tax efficient. The tax efficiency of an asset is essentially how much of its return is left after taxes are paid. Asset classes such as equities are considered tax efficient because taxes on their returns are generally only paid once and are taxed at a lower rate, according to IRS topic 409. When a stock is sold, the investor pays a federal capital gains tax (anywhere from 0-20% depending on his or her income) on its growth (plus any other applicable taxes such as state or healthcare taxes).

On the other end of the spectrum are high yield taxable bonds. They are considered tax inefficient in our opinion because taxes are paid on their income on an ongoing basis and at often higher regular income tax rates. A bondholder pays taxes annually at his or her marginal income tax rate on the interest the bond provides. Bonds, like many other assets, are an important component to any well-diversified portfolio, but serve an investor best in a specific part of a portfolio.

Callan Capital believes tax efficient assets are best placed in taxable brokerage accounts (e.g. individual, joint, or trusts), especially if not a lot of trading occurs, because these accounts have no specific tax advantages. Transactions that result in gains or income (i.e. purchases, sales, and dividends) are taxed each year.

In most cases, tax inefficient assets or strategies are best located in tax-deferred or tax-exempt accounts, such as traditional or rollover IRAs, Roth IRAs, and 401k accounts, because transactions are not taxable at the time they occur. This also includes frequently-traded equity strategies, like high turnover trading accounts, because of the gains — typically short term gains — they may be realizing on an ongoing basis. (Short term gains, resulting from the sale of positions held less than one year, are taxed at higher income tax rates, rather than the standard capital gains tax rates.)

While it is generally not prudent to let the "tax tail" wag the "investment dog" — meaning tax implications shouldn’t be the primary driver of investment decisions — being smart about locating different assets for tax purposes can provide a tailwind to long-run returns. As always, please consult a tax advisor for advice.

Note that an asset location strategy will likely result in performance dispersion between the accounts that make up a portfolio. Simply put, each account will have different returns while contributing to the overall return and goal of the portfolio. All family accounts should be combined in a diversified strategy, where each plays a specific role in the pursuit of achieving a financial goal.

Disclaimer: *Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at www.adviserinfo.sec.gov.


Katie J. Attebery, MBA is a Client Relationship Manager at Callan Capital in La Jolla, CA. Katie can be reached at 858.551.3800 or katie@callancapital.com. Callan Capital is an independent wealth management firm that provides financial planning and asset management services to affluent families, executives, foundations and endowments. For more information on asset location or Callan Capital’s suite of services, please visit www.callancapital.com.

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