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What is Asset Location?

May 14, 2020 Jack Sharry By Jack Sharry

There has been a lot of conversation across the industry over the past year about the importance of asset location. In the wake of volatile markets and uncertain times, you will be hearing a lot more.

We’ll discuss what asset location is and why it matters to investors and your bottom line.

What is Tax-smart Asset Location?

Tax-smart asset location can be achieved by locating tax-inefficient assets and income-producing investments (bonds, high turnover equities) in tax-advantaged accounts. Tax-efficient assets such as tax-exempt bonds, long term equities, and ETFs are best located in taxable accounts.

Asset allocation and asset location are sometimes confused. Asset allocation has long been a prudent method to manage all holdings in a household portfolio to maintain a desired risk profile. In the wake of historic change in the markets, many advisors are employing tax-smart asset location strategies to set the household portfolio on the right track to improve results over time as markets come back.

In keeping with the importance of managing both risk and tax, establishing the appropriate asset allocation comes first, and then each account should be organized to minimize taxes and maintain the overall household asset allocation by locating each asset in the optimal account.

By coordinating the management of risk and tax, improved results can be realized over time for both investors and advisors.

Tax Strategies to Improve Investor Outcomes

While we can’t control markets, we can control taxes.

This is important as taxes are the single largest cost investors incur over time, according to a Hearts & Wallets study. And advisors have plenty of opportunities to turn lemons into lemonade by helping investors manage taxes in the following ways:

  1. Tax-smart Asset Location
  2. Tax-loss Harvesting
  3. Tax-efficient Household Rebalancing
  4. Tax-smart Retirement Income

This post is focused on Tax-smart Asset Location and why it’s the first box to check to improve investor and advisor results over time.

“Location, Location, Location”

We all know “location” is the most important factor in real estate. The same can be said for investing. There are three different account types – taxable, tax-deferred, and tax-free – and each registration has a different tax treatment. Importantly, it matters that assets are held in the most advantageous accounts. A Morningstar study found asset location can add 50 basis points per year in value. Not only is asset location important for managing qualified and non-qualified assets, but it is also one of the reasons for the growing trend where tax-deferred annuities are being incorporated into managing a household portfolio to add additional asset location firepower.

Since managing taxes are so important generally – and even more so now – we have a series of posts on the opportunity to help your clients and your practice by managing portfolios at the household level.

Jack Sharry has been a financial industry innovator, collaborator and advocate for 40+ years. He served as an executive at Morgan Stanley, Putnam Investments, Virtus Investment Partners and now, LifeYield where he led sales, marketing, product development and distribution strategy. Jack is the Chair of the InvestmentNews Future of Financial Advice initiative and a frequent contributor to the publication, he Co-Chairs the Money Management Institute Digital Advice Community, and hosts the LifeYield podcast, WealthTech on Deck, where he talks with other industry leaders on their tech strategy designed to improve investor and advisor outcomes.