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Ways to Use Asset Location Strategies to Help Manage Your Taxes

A frequent question we field from prospective clients is related to “asset allocation.” While this can be an important component of any investment strategy, another consideration is where you place your investment dollars. Yes, we’re referring to an asset location strategy. 

Think about it this way: Every type of investment account has different tax rules that impact your net results – for example, 401(k) plan participation, a traditional IRA, a Roth IRA, and a traditional personal or joint brokerage account. The number of alternatives with different tax consequences makes asset location a viable strategy for prudent investors. 

Asset allocation and location sound similar but are very different asset management strategies.

Think of asset allocation like forming a balanced diet – a bit of protein, some carbs, and a helping of veggies. It’s all about mixing different types of investments, like stocks, bonds, alternative assets, and cash alternatives, in your portfolio. This mix is important because it helps you avoid putting all your eggs in one basket, so to speak, which can help manage your risk of losses if a particular investment or asset class takes a hit.

On the other hand, asset location is about finding suitable types of accounts for your investments from a tax perspective. Imagine you’re organizing your kitchen. You’d put fresh produce in the fridge, dry goods like grains in the pantry, and spices in a cool, dry spot. The goal? Seek to optimize the preservation of food for as long as possible.

Asset location is about pursuing the minimization of taxes. Every dollar saved is one more dollar for your future use. 

In today’s post, our team of Austin investment advisors will discuss different strategies for asset location to help you make the most of your investment returns as we head into a new year.

Understanding Asset Location

Asset location seeks to maximize the tax efficiency of your portfolios by taking advantage of the different tax treatments of various account types, such as taxable accounts, tax-deferred accounts (like IRAs and 401(k)s), and tax-free accounts (like Roth IRAs). 

Our mutual goal is to place investments in the account type that help manage the tax impact on your future returns while considering your financial profile, investment goals, and prevailing tax laws.

Asset location strategies for a tax-deferred 401(k) or traditional IRA

Here are a few asset location strategies to consider:

  • Bonds and other fixed-income securities generate interest income, taxed at ordinary income tax rates. By holding these types of investments in a 401(k) or traditional IRA, you defer taxes on the interest until you begin taking withdrawals during retirement years. At that point, you may be in a lower tax bracket. 
  • Real Estate Investment Trusts (REITs) often distribute taxable dividends at ordinary income rates. Placing REITs in tax-deferred accounts like a 401(k) or IRA also allows these dividends to grow tax-deferred, enhancing the compounding of returns and reducing your annual tax liability.
  • Mutual funds and other portfolios with high turnover rates can generate significant tax consequences on income and capital gains. Holding these types of investments in a tax-deferred account can avoid several types of taxes until you are ready to take distributions.

Asset location strategies for Roth IRAs

Because the assets in a Roth IRA grow tax-free, and distributions are tax-free¹, here are examples of investments that would benefit from this tax treatment. 

  • Placing high-appreciation potential investments, like common stocks, in a Roth IRA can be beneficial. Since the growth and withdrawals are tax-free, you can take advantage of any compound growth over time without worrying about tax consequences.
  • If you engage in frequent trading, placing these investments in a Roth IRA can avoid any short-term capital gains taxes associated with these transactions and provide tax-free distributions.
  • Alternative investments that might otherwise generate taxable income each year, such as precious metals, commodities, or managed futures, could also be invested in a Roth IRA to benefit from potential tax-free growth.
¹ A qualified distribution is a distribution which is made after the five-year holding period and is made on account of one of the following events: reached age 59½, disability, the purchase of a first home up to the lifetime limit or your death.

 

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Asset location strategies for taxable accounts

Asset location strategies involve investing in tax-efficient accounts that seek to maximize returns. For taxable accounts, this typically means focusing on investments that are taxed at lower rates or that can benefit from long-term capital gains treatment. 

Here are some examples:

  • Keeping stocks or equity funds in taxable accounts for more than a year can qualify the gains for long-term capital gains tax rates, usually lower than short-term rates.
  • Investing in municipal bonds is a common strategy for taxable accounts because the interest income from these bonds is often exempt from federal income taxes and, in some cases, state and local taxes.
  • Index Funds are designed to minimize taxable distributions by employing low turnover and loss harvesting strategies, making them suitable for taxable accounts.
  • Investing in assets that pay qualified dividends can benefit taxable accounts, as qualified dividends are taxed at the lower long-term capital gains tax rates.
  • Realizing capital losses in a taxable account can offset capital gains and up to $3,000 of ordinary annual income, reducing the overall tax burden.

 

How Beck Capital Management Can Help You Create Asset Location Strategies

When it comes to asset location, we follow our slogan: Tax-wise, Money Smart Investment Management. We consistently evaluate asset location, and its tax impact on your portfolio. Don’t just think of us as another firm managing your wealth but as your financial ally and advocate. Our services go far beyond simply trading stocks and bonds; we focus on crafting a tailored suite of services to help you meet your long-term financial goals.

At the heart of any investment strategy is a thorough understanding of what matters most to you: your dreams, your concerns, your current family situation, and any immediate financial needs you may have.

Our investment strategy starts with what we call our “30,000-foot view.” This broad, global perspective includes examining the current economic climate, long-term trends, currency challenges, and money flow both in and out of the U.S. Missing this big-picture, top-down view could mean overlooking exciting investment opportunities.

What sets our approach apart is our exceptional, in-house investment team. They’re always monitoring the big economic indicators like interest rates, foreign exchange, company earnings, etc. 

We’re also big believers in the power of sector rotation to unlock investment opportunities in today’s complex global economy. We can tap into the trends and developments fueling growth in those areas by zeroing in on specific economic sectors that are currently in favor.

This focused approach allows us to concentrate on the investments we feel are poised for the most significant growth. With a suitable mix of discipline and know-how, sector rotation can lead to competitive returns and help manage risk, crafting an investment strategy in sync with the global economy.

Our continuous analysis is designed to keep your financial portfolio poised for success, no matter how the market shifts and turns.

Connect with us to learn more about our asset location strategies.

 
Nothing contained herein is to be considered a solicitation, research material, an investment recommendation or advice of any kind. The information contained herein may contain information that is subject to change without notice.  Any investments or strategies referenced herein do not take into account the investment objectives, financial situation or particular needs of any specific person. Product suitability must be independently determined for each individual investor.
Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market.  They are methods used to help manage investment risk.
Beck Capital Management does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.
Please consider the investment objectives, risks, charges, and expenses carefully before investing in Mutual Funds. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.  There are risks associated with these types of investments and include but are not limited to the following:  Typically no secondary market exists for the security listed above.  Potential difficulty discerning between routine interest payments and principal repayment.  Redemption price of a REIT may be worth more or less than the original price paid.  Value of the shares in the trust will fluctuate with the portfolio of underlying real estate. There is no guarantee you will receive any income. Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.  This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein.  The offering is made only by the Prospectus.
Investing in securities involves risk of loss that clients should be prepared to bear.  No investment process is free of risk; no strategy or risk management technique can guarantee returns or eliminate risk in any market environment.  There is no guarantee that your investment will be profitable.  Past performance is not a guide to future performance.  The value of investments, as well any investment income, is not guaranteed and can fluctuate based on market conditions. 

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