What Is Asset Location and How to Invest in the Right Accounts

When it comes to investing, the term “locate” refers to where you choose to keep your money — between tax-advantaged, tax-free, and taxable accounts – in order to optimize after-tax profits. Asset location is the process of strategically placing your assets within each type of account in order to minimize your tax liability. It’s a critical part of an effective overall investment strategy. For example, let’s say you have $10,000 to invest. You could put all $10,000 into a single taxable brokerage account. But if you spread your money out among different types of accounts, you’ll pay less in taxes.

Why Should You Care About Asset Location?

The goal of asset location is to minimize your tax liability. By placing assets in the right type of account, you can save yourself a lot of money in taxes. For example, let’s say you have $10,000 to invest. You could put all $10,000 into a single taxable brokerage account. But if you spread your money out among different types of accounts, such as a traditional IRA and Roth IRA, you’ll pay less in taxes on the assets that generate long-term profits — typically stocks and bonds.

How To Figure Out Your Best Asset Locations

The first step in asset location is to figure out which type of account is best for each type of asset. Below is a quick summary of different types of accounts and where to locate your investments.

Taxable Brokerage Accounts

Taxable brokerage accounts are best for short-term investments, such as stocks and bonds that you plan to sell within one year. You’ll pay taxes on any profits you make, but you can also write off any losses against your income.

529 College Savings Plans

529 college savings plans are best for long-term investments, such as stocks and bonds that you plan to hold for more than five years. You won’t pay taxes on the investments’ earnings, but you will have to pay income tax if you withdraw money from your 529 plan account for noneducational purposes before age 30 or penalties if you withdraw it at any time after that.

Tax-Free Retirement Accounts

Roth IRA accounts are best for stocks and bonds that you expect to hold long-term. You won’t pay any taxes on the investments’ earnings, but you do have to pay income tax upfront on the money you deposit in your Roth IRA account. With a traditional IRA, you’ll pay income tax at withdrawal, but only if your annual withdrawals exceed a certain amount.

401(k) and Other Employer-Sponsored Retirement Accounts

Employer-sponsored retirement accounts, such as 401(k) plans, are best for long-term investments such as stocks and bonds that you plan to hold for more than five years. Your contributions may be tax-deductible, and your investments will grow tax-deferred. You’ll pay income tax on the money you withdraw at withdrawal, but only if your annual withdrawals exceed a certain amount. Roth 401(k) accounts are best for stocks and bonds that you expect to hold long-term.

Tax-Free Savings Accounts

Tax-free savings accounts are best for short-term investments, such as stocks and bonds that you plan to sell within one year. You won’t pay taxes on the investments’ earnings, but if you withdraw money before age 59 1/2, you’ll pay income tax and a 10% penalty on any profits.

Common Mistakes With Asset Location

The biggest mistake investors make with asset location is failure to implement the strategy. Many people fail to consider how putting their investments in different types of accounts will affect their profits after taxes. Failing to take full advantage of retirement accounts is another mistake investors often make with asset location. You can only contribute a certain amount of money annually to your IRA and 401(k). So if you have more than that amount in stocks or bonds, it would be wise to take the excess profits from those investments and put them in your IRA or 401(k).

Simplified Asset Location Tips

The best way to implement an effective asset location strategy is to consider each type of account’s tax benefits, its contribution limits and the types of investments you plan to hold. Then you can figure out which types of assets belong in which accounts based on the following general rules: -Short-term investments, such as stocks and bonds that you plan to sell within one year, should go in taxable brokerage accounts. -Long-term investments, such as stocks and bonds that you plan to hold for more than five years, should go in tax-advantaged retirement accounts or 529 college savings plans. -Taxable brokerage accounts are best for both short-term and long-term investments that you expect will generate substantial capital gains or losses, such as stocks and bonds.

The Bottom Line

Asset location is an important consideration for all investors, whether they’re just starting out or they’ve been investing for years. By understanding the different types of accounts and their tax benefits, you can put your investments in the best place to help you save on taxes and achieve your investment goals.

Asset location is the process of strategically placing investments in different types of accounts to minimize taxes. For example, if you have stocks that are expected to generate substantial capital gains in your taxable brokerage account, it would be best to put them in a tax-advantaged retirement account such as a 401(k) or IRA where you won't have to pay taxes on the profits.
Asset location is important because it can help you save on taxes and achieve your investment goals. By strategically placing your investments in different types of accounts, you can take advantage of the tax benefits that each account offers. For example, you can put short-term investments in a regular brokerage account, while putting your long-term investments in tax-advantaged retirement accounts.
Before you implement an asset location strategy, it's important to understand the different types of accounts that are available to you. You should also be familiar with how each type of account is taxed. Then you can figure out which type of assets belong in which accounts based on the following general rules: -Short-term investments, such as stocks and bonds that you plan to sell within one year, should go in taxable brokerage accounts. -Long-term investments, such as stocks and bonds that you plan to hold for more than five years, should go in tax-advantaged retirement accounts or 529 college savings plans. -Taxable brokerage accounts are best for both short-term and long-term investments that you expect will generate substantial capital gains or losses, such as stocks and bonds.
The best way to implement an effective asset location strategy is to consider each type of account's tax benefits, its contribution limits and the types of investments you plan to hold.
The most common mistake investors make with asset location is not understanding the different types of accounts available to them. Another mistake is putting all of their investments in one type of account, such as a 401(k), instead of diversifying among different types of accounts. Investors should also be aware that they may not be able to deduct all of their losses from taxable accounts on their tax returns.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.