Asset Location

Why this matters

This optional lesson is for anyone with money in more than one kind of account, such as a 401(k) and an ordinary brokerage account. Once you have both, the same portfolio can be arranged in different ways, and some arrangements leave more for you after tax than others. It's a refinement, not a foundation: get the allocation right first.

Allocation and location

Asset Allocation decides how your money is split between stocks, bonds, and cash. Asset location decides where each part is held: in a taxable account, a tax-deferred account such as a traditional 401(k), or a Roth account. The allocation stays the same; only the placement changes.

How investment income is taxed in a taxable account

• Interest from bonds and savings is generally taxable each year as regular income.¹ Interest on bonds issued by state and local governments generally isn't taxable.¹
• Dividends are taxed each year. Ordinary dividends are taxed as regular income; qualified dividends are taxed at the lower capital gains rates.²
• Gains are taxed when you sell, and the rate on most long-term gains is no higher than 15% for most people.³ Funds can also pay out the gains from their own sales as a capital gains distribution, which is taxable even if you never sold a share.⁴

Inside a tax-advantaged account, none of this is taxed year to year. So the shelter is worth the most for investments that would otherwise produce the most taxable income each year.

What research suggests

A study by John Shoven and Clemens Sialm found that, for an investor saving for retirement, taxable bonds have a preferred location in the tax-deferred account, and tax-exempt municipal bonds belong in the taxable account for investors in high enough tax brackets. Tax-efficient stock funds, such as passively managed ones, were better held in the taxable account, and tax-inefficient, actively managed stock funds in the tax-deferred account. Locating assets this way, the authors found, can significantly improve risk-adjusted results.⁵

Investment	Why	Tends to fit best in
Taxable bond funds	Interest is taxed each year as regular income	Tax-advantaged accounts
Actively managed stock funds	Frequent selling can pass taxable gains to you	Tax-advantaged accounts
Broad stock index funds	Mostly qualified dividends and few realized gains	Either; often the taxable account
Municipal bonds	Interest is generally already free of federal tax	Taxable account, if held at all

General tendencies, not rules. Individual funds differ, and so do tax situations.

The rest of this lesson is for members

Still to come in this lesson: A worked example, The practical limits, the key takeaways, and 2 quiz questions with explanations.

Membership opens every lesson in the curriculum, the capstone projects, the interactive tools, and the members-only channels in the Hyperion Entities Discord. The first lesson of every module stays free.

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