Location, location, location
We at Vanguard educate, cajole, and opine everywhere on the importance of keeping your investment portfolio diversified and matched closely with your risk profile. We should be saying more about just where you’re keeping those investments.
Perhaps everyone’s been lulled into a state of numbness with income tax rates at their current level. Complain as we might, these rates have been much higher, and it’s difficult to envision a scenario in which they won’t begin their seemingly inexorable rise again. Once the Bush tax cuts are no more, the estate tax is figured out, and the taxes approved in the health care legislation kick in, the tax bite should arouse us from this lethargy.
There are some things in your control—and one of those is asset location. You can avoid or delay some of the sting by making sure you have positioned assets where they may avoid unnecessary or early taxation.
If you are looking for background and possible approaches based on a number of specific scenarios, check out this paper written by my colleague Colleen Jaconetti. Colleen posits that tax-inefficient investments or strategies should only be added to a portfolio if their inclusion is expected to increase returns (net of taxes and implementation costs) or reduce the overall volatility of the portfolio. Good words to live by for all investments in your portfolio, but very important to keep in mind here because of the tax burden accompanying these types of assets.
If you’re looking for basic rules of thumb, you might check out this Forbes article. It includes a great sliding scale of tax-efficiency of investments that may be of some interest.
This is a good time to take a look at not only what you hold, but also where you hold it.
Notes:
- The link to Forbes.com will open a new browser window. Except where noted, Vanguard accepts no responsibility for content on third-party websites. Opinions presented on such sites are those of their authors and do not necessarily reflect the views of Vanguard or its management. None of the content on such sites should be construed as advice from Vanguard.
- Diversification does not ensure a profit or protect against a loss in a declining market.
Thank you for the information.
One comment: tax avoidance is legal; tax evasion is illegal. In your 3rd paragraph, instead of “… evade unnecessary or early taxation” I think that “… avoid unnecessary or early taxation” would better express your point.
Does Vanguard have an investor aide that would:
1. combine asset allocation: stock, bond, cash (rows), 2. Asset location (columns: a. taxable accounts, b. deferred taxes accounts and c. Roth) 3. suggested type of assets in each cell and then suggested Vanguard MFs/ETFs, by number in each cell. Putting it all together in one spreadsheet would be very helpful for me.
Thanks for asking what would help the average investor.
The July 5 comment was excellent though it may be too much to ask for. Location of assets can have another meaning. Would anyone comment on diversisfication of custodians for the sake of security? That’s a subject I would like to see addressed.
The reader who commented on July 2 at 7:30 p.m. raised an excellent point. We certainly don’t encourage anyone to “evade” taxes. That was a miss on our part. I’ve changed it to “avoid.” Thank you for the catch!
- Ellen Rinaldi
I did read the Forbes article. It says to put the most tax-inefficient investments into tax-deferred retirement accounts such as traditional IRA’s, 403b’s, and 401(k)’s. It also says to put the next most tax inefficient investments into Roth IRA’s and Roth 401(k)’s. That doesn’t make sense. The investments which generate the largest volumes of the most inefficiently taxable income should go into the Roth accounts, which will probably never lead to taxable income anyhow.