Asset Location Optimization

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What You’ll Learn

1. ✅ Understand what asset location is and why it matters
2. ✅ Determine which investments go in which account types
3. ✅ Calculate the tax savings from optimal asset location
4. ✅ Implement asset location strategy across multiple accounts
5. ✅ Avoid common asset location mistakes that cost thousands
6. ✅ Rebalance across accounts while maintaining optimal location
7. ✅ Adjust asset location as your situation changes

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What is Asset Location?

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Asset Allocation vs. Asset Location

• Example: 70% stocks, 30% bonds
• Determines your risk/return profile

• Example: Stocks in Roth IRA, bonds in Traditional IRA
• Determines your tax efficiency
• Can add 0.2-0.75% annually to after-tax returns!

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The Core Principle

• Tax-advantaged accounts (IRAs, 401ks) shield investments from taxes
• Wasting that shield on already-tax-efficient investments is inefficient
• Taxable accounts get hit with taxes every year
• Minimize taxes in taxable by holding tax-efficient assets there

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The Three Account Types

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Type 1: Taxable Brokerage Accounts

• No contribution limits (invest unlimited amounts)
• No withdrawal penalties (access anytime)
• TAXED every year on:
  • Dividends
  • Interest
  • Capital gains (when you sell)
• Long-term capital gains taxed at 0%, 15%, or 20% (held >1 year)
• Short-term capital gains taxed as ordinary income (held <1 year)
• Foreign tax credits available (international stock dividends)

• Flexibility (withdraw anytime without penalty)
• Step-up in cost basis at death (heirs inherit tax-free)
• Foreign tax credit (can’t claim in IRA)

• Annual tax drag from dividends, interest, capital gains
• Less compounding (taxes reduce growth)

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Type 2: Traditional IRA / 401(k) (Tax-Deferred)

• Contributions are tax-deductible (reduce taxable income now)
• NO TAXES while invested (dividends, interest, gains all tax-free internally)
• Taxed as ordinary income when withdrawn (retirement)
• Required Minimum Distributions (RMDs) starting at age 73
• Contribution limits: $7,000/year IRA,$23,000/year 401k (2024)
• 10% penalty + taxes if withdrawn before age 59.5

• Tax deduction today (lower current taxes)
• Tax-deferred growth (compound without tax drag)
• Great for high earners (deduction at high tax bracket, withdraw at lower bracket in retirement)

• All withdrawals taxed as ordinary income (even capital gains!)
• Forced withdrawals (RMDs)
• Can’t claim foreign tax credit

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Type 3: Roth IRA / Roth 401(k) (Tax-Free)

• Contributions are NOT tax-deductible (pay taxes now)
• NO TAXES ever again (dividends, interest, gains all tax-free)
• Withdrawals in retirement are 100% tax-free
• NO Required Minimum Distributions (can leave to heirs)
• Contribution limits: $7,000/year IRA,$23,000/year 401k (2024)
• Contributions (not earnings) can be withdrawn anytime penalty-free

• Tax-free growth forever (most powerful for long-term)
• Tax-free withdrawals (avoid taxes in retirement)
• No RMDs (great for estate planning)
• Hedge against future tax rate increases

• No tax deduction today (pay taxes now)
• Contribution limits (can’t put unlimited amounts)
• Income limits for Roth IRA (high earners may not qualify)

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Tax Efficiency Hierarchy

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Most Tax-Efficient → Least Tax-Efficient

• VTI, SCHB, ITOT (U.S. total market)
• VXUS, IXUS, SCHF (International total market)
• Why: Low turnover (rarely sell), minimal capital gains distributions
• Typical annual tax drag: 0.1-0.3%

• Companies that don’t pay dividends (Amazon, Google, Berkshire, etc.)
• Why: No dividend income to tax annually, only taxed when YOU sell
• Typical annual tax drag: 0-0.2%

• Interest is federally tax-exempt (and often state tax-exempt)
• Why: Designed for taxable accounts
• Typical annual tax drag: 0%

• Vanguard Tax-Managed funds (VTMFX, etc.)
• Why: Specifically designed to minimize taxable distributions
• Typical annual tax drag: 0-0.1%

• Qualified dividends taxed at 0-20% (preferential rate)
• Why: Some tax drag from dividends, but qualified rate is lower than ordinary income
• Typical annual tax drag: 0.5-1.5% (depending on yield)

• Often have higher dividend yields than growth funds
• Why: More dividend income = more annual taxes
• Typical annual tax drag: 0.5-1.0%

• VEA, VXUS pay foreign taxes (can claim credit in taxable account)
• Why: Foreign tax credit valuable, but also generates dividends
• Typical annual tax drag: 0.3-0.7% (net of foreign tax credit)

• REITs (pay 90%+ of income as dividends)
• Dividend aristocrats yielding 4-6%
• Why: Large annual dividend income taxed every year
• Typical annual tax drag: 2-4%

• Dividends taxed as ordinary income (NOT qualified dividends!)
• Why: Highest tax burden, taxed at 22-37%
• Typical annual tax drag: 3-8%

• Interest taxed as ordinary income annually
• Why: High annual income, all taxed at ordinary rates
• Typical annual tax drag: 1.5-4%

• Frequent trading generates capital gains distributions
• Why: Manager’s trades create taxable events YOU pay for
• Typical annual tax drag: 1-3%

• “Phantom income” from inflation adjustments (taxed annually even though you don’t receive cash)
• Why: Tax nightmare in taxable accounts
• Typical annual tax drag: 1-2%

• 6-8% annual interest, all taxed as ordinary income
• Why: Massive annual tax drag
• Typical annual tax drag: 4-8%

• Complex tax treatment (60/40 rule)
• Why: Generates K-1s, complicated taxes
• Typical annual tax drag: Varies wildly

• Foreign tax withholding + ordinary income tax
• Why: Double taxation issue
• Typical annual tax drag: 2-5%

• Generates K-1 tax forms (complex)
• Why: Can create “unrelated business taxable income” (UBTI) in IRAs
• Typical annual tax drag: Complex, consult CPA

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The Optimal Asset Location Strategy

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The Priority System

1. Small-cap growth stocks (highest long-term return potential)
2. Emerging market stocks (high growth, high volatility)
3. Individual high-growth stocks (if you pick stocks)
4. Sector ETFs with highest growth (tech, innovation, etc.)

• $6,000 small-cap growth (VBK or SCHA)
• $3,000 emerging markets (VWO or IEMG)
• $1,000 individual growth stock (your highest conviction pick)

1. Bonds (Treasury, corporate, high-yield)
2. REITs (real estate investment trusts)
3. High-dividend stocks (dividend aristocrats, utilities)
4. Actively managed funds (if you must own them)
5. International bonds

• $30,000 bonds (BND, AGG)
• $10,000 REITs (VNQ)
• $10,000 high-dividend stocks (utilities, telecoms)

1. U.S. total market index funds (VTI, SCHB)
2. S&P 500 index funds (VOO, IVV)
3. International stocks (VEA, VXUS) - to claim foreign tax credit
4. Municipal bonds (for high earners)
5. Non-dividend-paying growth stocks
6. Tax-managed funds

• $60,000 VTI (U.S. total market)
• $30,000 VXUS (international stocks)
• $10,000 municipal bonds (if high tax bracket)

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Complete Example: $200,000 Across Three Accounts

• 100% Small-Cap/Emerging Markets:
  • $12,000 VBK (small-cap growth)
  • $8,000 VWO (emerging markets)

• 50% Bonds, 50% REITs/High-Dividend:
  • $40,000 BND (total bond market)
  • $20,000 VNQ (REITs)
  • $20,000 SCHD (dividend-focused stocks)

• 100% Tax-Efficient Stocks:
  • $70,000 VTI (U.S. total market)
  • $30,000 VXUS (international stocks)

• Stocks:
  • Roth: $20k (small-cap + EM)
  • Trad: $20k (dividend stocks)
  • Taxable: $100k (broad market)
  • Total: $140k = 70% ✅ (close to 60% target, bit aggressive but OK)
• Bonds:
  • Roth: $0
  • Trad: $40k
  • Taxable: $0
  • Total: $40k = 20% (below 40% target)
• REITs:
  • Trad: $20k = 10%

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Better Example: $200,000 True 60/40

• $20,000 VWO (emerging markets - highest growth potential)

• $60,000 BND (bonds - tax-inefficient)
• $20,000 VNQ (REITs - tax-inefficient)

• $60,000 VTI (U.S. stocks - tax-efficient)
• $40,000 VXUS (international stocks - foreign tax credit)

• Stocks: $20k (EM) +$60k (U.S.) + $40k (intl) =$120k = 60% ✅
• Bonds: $60k = 30%
• REITs: $20k = 10%
• Total: $200k ✅

• Roth: Highest growth asset (EM) grows tax-free forever
• Traditional IRA: Tax-inefficient bonds and REITs shielded from annual taxes
• Taxable: Most tax-efficient stocks (low dividends, low turnover)

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Calculating Tax Savings from Asset Location

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The Math

• $100,000 in bonds yielding 4%
• Annual interest: $4,000
• Tax rate: 24% (ordinary income)
• Annual tax: $4,000 × 24$960

• Total tax drag: $960/year × 30 years =$28,800
• Plus lost compounding on that $960 annually

• $100,000 in VTI yielding 1.5% (dividends)
• Annual dividends: $1,500
• Tax rate: 15% (qualified dividends)
• Annual tax: $1,500 × 15$225

• $100,000 in bonds yielding 4%
• Annual interest: $4,000
• Tax: $0 (sheltered in IRA until withdrawal)

• Wrong way: $960/year
• Right way: $225/year
• Savings: $735/year

• Total tax savings: $735 × 30 =$22,050
• Plus compounding: ~$40,000+

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Use Sage to Calculate Your Savings

Hey Sage, help me calculate my tax savings from optimizing asset location:

MY CURRENT SETUP (suboptimal):
- Taxable brokerage: $[amount] in [high-dividend stocks / bonds / REITs]
  - Annual income generated: $[amount]
  - Tax rate on that income: [%]

- Traditional IRA: $[amount] in [growth stocks / index funds]

MY PROPOSED OPTIMAL SETUP:
- Taxable brokerage: $[amount] in [tax-efficient stocks like VTI]
  - Annual income generated: $[amount]
  - Tax rate: [%]

- Traditional IRA: $[amount] in [bonds / REITs / high-dividend stocks]
  - Annual income: $[amount]
  - Tax rate: 0% (sheltered)

Calculate:
1. Annual tax with current setup
2. Annual tax with optimal setup
3. Annual tax savings
4. 30-year tax savings (with compounding at [%] return)

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Implementing Asset Location

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Step 1: List All Your Accounts

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Step 2: List All Your Desired Holdings

• U.S. Stocks (VTI): 50% = $125,000
• International Stocks (VXUS): 10% = $25,000
• Emerging Markets (VWO): 10% = $25,000
• Bonds (BND): 25% = $62,500
• REITs (VNQ): 5% = $12,500

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Step 3: Assign Holdings to Accounts (Optimal Location)

• $25,000 VWO (emerging markets)

• $62,500 BND (bonds)
• $12,500 VNQ (REITs)
• $75,000 ??? (need to fill remaining space)

• $62,500 BND
• $12,500 VNQ
• $75,000 VTI (U.S. stocks - fill remaining IRA space)

• $50,000 VTI (U.S. stocks)
• $25,000 VXUS (international stocks - foreign tax credit)

• VTI: $75k +$50k = $125k = 50% ✅
• VXUS: $25k = 10% ✅
• VWO: $25k = 10% ✅
• BND: $62.5k = 25% ✅
• VNQ: $12.5k = 5% ✅

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Step 4: Execute Trades to Reposition

• Taxable: $75k all in high-dividend stocks
• IRAs: $150k all in VTI
• Roth: $25k in BND

• Sell $75k high-dividend stocks
• Buy $50k VTI +$25k VXUS

• Sell $75k VTI
• Buy $62.5k BND +$12.5k VNQ

• Sell $25k BND
• Buy $25k VWO

• Taxable account sales: May trigger capital gains taxes (consider tax-loss harvesting if available)
• IRA/Roth sales: NO tax implications (can reposition freely!)

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Special Situations

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Situation #1: Only Have Taxable Account (No IRA)

• Focus 100% on tax-efficient holdings
• Avoid: Bonds, REITs, high-dividend stocks
• Use: VTI, VXUS, municipal bonds (if high tax bracket), growth stocks

• $60,000 VTI (U.S. stocks)
• $30,000 VXUS (international)
• $10,000 MUB (municipal bonds - tax-exempt)

• Accept higher stock allocation (more aggressive)
• Use muni bonds (lower yield but tax-free)
• Open an IRA! (even if it’s just $7,000/year, it helps)

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Situation #2: Only Have 401(k) / IRA (No Taxable)

• Doesn’t matter WHERE you put assets (all are tax-sheltered)
• Focus on normal asset allocation (60/40, 70/30, etc.)
• Withdraw in retirement as ordinary income

• $140,000 VTI (70% stocks)
• $60,000 BND (30% bonds)

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Situation #3: High Earner (Can’t Contribute to Roth)

1. Contribute to Traditional IRA (non-deductible)
2. Immediately convert to Roth IRA
3. No income limits on conversions!

• No income limits for Roth 401(k)
• Can contribute even if you make $500k/year

• Put growth stocks in Roth 401(k) (if available)
• Put bonds/REITs in Traditional 401(k)
• Put tax-efficient stocks in taxable

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Situation #4: Approaching Retirement (Need Income)

• Bonds in IRA (defer taxes)
• Stocks in taxable (tax-efficient growth)

• Bonds in taxable (generate income, pay lower capital gains tax on principal)
• Stocks in Roth (let tax-free growth continue for heirs)
• Use Traditional IRA first (required RMDs anyway)

• In retirement, you WANT taxable accounts to generate income (lower taxes than IRA withdrawals)
• Roth becomes legacy account (pass to heirs tax-free)

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Common Asset Location Mistakes

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Mistake #1: Bonds in Taxable Account

• Bonds generate 3-5% annual interest
• Interest taxed as ordinary income (22-37% brackets)
• Annual tax drag: 0.7-1.9% (enormous!)

• Bonds in IRA (defer taxes)
• Stocks in taxable (minimal dividends)

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Mistake #2: REITs in Taxable Account

• REIT dividends taxed as ordinary income (NOT qualified dividends)
• 4% yield × 24% tax rate = 0.96% annual tax drag
• Plus: No foreign tax credit, no step-up in basis at death

• REITs in IRA/401k ONLY
• Never hold REITs in taxable

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Mistake #3: International Stocks in IRA

• International stocks pay foreign taxes (15-30%)
• In IRA: Can’t claim foreign tax credit (lost forever)
• In taxable: Can claim credit on tax return (recover most/all)

• International stocks in taxable (claim foreign tax credit)
• U.S. stocks can go in either

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Mistake #4: Growth Stocks in Traditional IRA (Not Roth)

• Growth stocks might 10× over 20 years
• In Traditional IRA: All gains taxed as ordinary income when withdrawn (22-37%)
• In Roth: All gains tax-free forever (0%)

• $10,000 invested in NVIDIA in 2018
• 2024: Worth $100,000 (10× gain)

• $100,000 withdrawal taxed at 24$24,000 tax
• You keep: $76,000

• $100,000 withdrawal,$0 tax
• You keep: $100,000

• Highest-growth stocks in Roth
• Bonds/stable assets in Traditional

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Mistake #5: Not Rebalancing Across Accounts

• Doesn’t maintain optimal tax location
• Forces selling low-tax-drag assets in taxable
• Generates unnecessary taxes

• Taxable: Rebalance to 60% stocks, 40% bonds
• IRA: Rebalance to 60% stocks, 40% bonds
• Problem: Now you have bonds in taxable (inefficient!)

• View ALL accounts as one portfolio
• Rebalance across accounts to maintain:
  • Overall 60/40 allocation
  • Optimal tax location (bonds in IRA, stocks in taxable)

• Calculate portfolio-wide allocation
• Rebalance to targets while respecting tax location
• Might mean 80/20 in taxable, 40/60 in IRA (averages to 60/40 overall)

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Using Sage for Asset Location Planning

Hey Sage, help me optimize my asset location across accounts:

MY ACCOUNTS:
- Roth IRA: $[amount]
- Traditional 401(k): $[amount]
- Traditional IRA: $[amount]
- Taxable Brokerage: $[amount]
- Total: $[amount]

MY TARGET ALLOCATION:
- U.S. Stocks: [%]
- International Stocks: [%]
- Emerging Markets: [%]
- Bonds: [%]
- REITs: [%]
- Other: [%]

Can you recommend:
1. Which assets should go in which accounts for optimal tax efficiency?
2. Specific dollar amounts for each holding in each account
3. Estimated annual tax savings vs. suboptimal location
4. Any trades I need to make to reposition (and tax implications)
5. How to rebalance in the future while maintaining optimal location

Hey Sage, help me optimize my asset location across accounts:

MY ACCOUNTS:
- Roth IRA: $30,000
- Traditional 401(k): $150,000
- Taxable Brokerage: $120,000
- Total: $300,000

MY TARGET ALLOCATION:
- U.S. Stocks (VTI): 50%
- International Stocks (VXUS): 15%
- Emerging Markets (VWO): 5%
- Bonds (BND): 25%
- REITs (VNQ): 5%

MY TAX SITUATION:
- Marginal tax bracket: 24%
- Capital gains rate: 15%

Can you recommend:
1. Which assets should go in which accounts for optimal tax efficiency?
2. Specific dollar amounts for each holding in each account
3. Estimated annual tax savings vs. if I just held 50/15/5/25/5 in each account

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Success Checklist

• Understood the difference between asset allocation and asset location
• Learned the tax efficiency hierarchy (bonds least efficient, index funds most efficient)
• Identified all your account types (taxable, Traditional, Roth)
• Calculated your current asset location (where is what held now?)
• Designed optimal asset location strategy for your accounts
• Calculated estimated tax savings from optimization
• Planned trades to reposition assets (if needed)
• Set annual review to maintain optimal location
• Learned to rebalance across accounts (not within each account)
• Used Sage to validate your asset location plan

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What’s Next?

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Related Workflows:

• Tax-Loss Harvesting - Combine with asset location for max tax savings
• Multi-Account Portfolio Management - Coordinate across accounts
• Rebalancing Your Portfolio - Rebalance across accounts
• Monthly Portfolio Review - Monitor tax efficiency

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Continue Learning:

• Read “The Bogleheads’ Guide to Tax-Efficient Investing”
• Use portfolio tracking tools (Personal Capital, Empower)
• Consult CPA for complex situations ($500k+ portfolios)
• Join r/Bogleheads (asset location experts)

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Take Action:

• This week: Map current asset location
• This month: Calculate tax savings from optimization
• This quarter: Reposition assets (prioritize tax-advantaged accounts first)
• Annually: Review and maintain optimal location