While people like to focus on what “hot” stock to purchase or the next “get rich” investing scheme, we like to focus on the tried and true principles of financial planning, and a BIG one is tax planning. Let’s start with a concept called Asset Location, which the Vanguard Group study “Putting a Value on your Value…”¹ stated can add up to an additional .75% in return by reducing taxes.
The concept is simple but requires having a qualified account like an IRA or 401k and a non-qualified account such as an Individual or Joint. As long as you build a diversified portfolio you will have some assets that are more tax efficient than others. To take advantage of Asset Location, put the more tax efficient assets in the non-qualified account and the less tax efficient assets in the qualified account. In general, stocks are going to be more efficient than bonds. Most of their gain comes from appreciation, on which you pay capital gains tax at a max rate of 23.8%, whereas most bond returns come from dividends, which are taxed at income tax rates at a max of 39.6%.
For example: John owns a $400,000 IRA and a $600,000 Individual account and invests with a middle of the road risk level (60% stocks and 40% bonds). He would want to purchase all of the bonds in his IRA and all of his stocks in his individual account. This example fits perfectly, where obviously most won’t, but the closer you get to this distribution the closer you will be to the additional .75% in return. While .75% doesn’t seem like a lot over a year, in John’s situation if you extrapolate it over 10 years it’s over $77,000 of additional return. So, even if you manage to find a “hot” stock that makes an additional $50,000, you have to ask yourself is it worth it to take the risk? Or should you focus your time and energy on a strategy that you know will earn more return with no downside. I know where I am concentrating my time and effort.
