What is Asset Location and How Can It Benefit Your Mixed-Account Portfolio?
Asset location is a tax-aware step that complements asset allocation. Where you hold an asset—taxable brokerage account, tax-deferred account like a 401(k) or traditional IRA, or tax-exempt account such as a Roth IRA—affects how future returns are taxed. Over long time horizons, those differences can compound into meaningful variations in after-tax wealth.
This article explains how asset location works, shows practical examples for mixed-account portfolios, and provides a checklist you can use to run your own analysis. The guidance below is educational; consult a tax or financial advisor about your specific situation.
Sources: IRS Publication 550 on investment income (https://www.irs.gov/publications/p550) and IRS guidance on IRAs (https://www.irs.gov/retirement-plans).
Why account type matters: tax treatments at a glance
- Taxable accounts: Investment income (dividends, interest, short-term gains) and realized capital gains are taxed in the year they occur. Long-term capital gains and qualified dividends typically receive preferential federal rates versus ordinary income (see IRS Pub 550).
- Tax-deferred accounts (401(k), traditional IRA): Contributions may be pre-tax and grow tax-deferred. Withdrawals are taxed as ordinary income in retirement.
- Tax-exempt accounts (Roth IRAs): Contributions are made with after-tax dollars; qualified withdrawals are tax-free, including earnings (see IRS Publication 590).
Because different assets generate income and gains in different ways, holding them in the account with the most favorable tax treatment usually improves after-tax returns.
How to think about asset placement (practical framework)
- Start with the expected tax treatment of returns
- Interest and non-qualified dividends generate ordinary income. Those are usually best inside tax-deferred accounts where ordinary income tax on withdrawals may be preferable to annual taxation.
- Qualified dividends and long-term capital gains are taxed at preferential rates in a taxable account, making tax-efficient equity ETFs and index funds good candidates for brokerage accounts.
- High-growth assets that produce little current income but substantial future appreciation (e.g., early-stage growth stocks) are attractive inside Roth accounts because withdrawals are tax-free.
- Consider turnover and rebalancing costs
- Actively managed mutual funds or taxable bond funds can generate frequent taxable distributions—these are often better in tax-deferred accounts.
- Low-turnover index ETFs tend to be tax-friendly in taxable accounts.
- Combine with your expected tax bracket in retirement
- If you expect to be in a lower tax bracket in retirement, some income-producing assets in tax-deferred accounts can make sense. If you expect higher future rates or bracket, favor Roth placement for growth.
- Factor in state taxes, alternate minimum tax (AMT), and special treatments
- Municipal bond interest is often tax-free at the federal level when held in taxable accounts and loses that benefit inside tax-deferred accounts. State tax rules can also change the decision.
Practical examples with numbers (illustrative)
Example A — High-growth stock vs. bond fund
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Scenario: You have $100,000 to invest and two accounts: a taxable brokerage account and a Roth IRA. You expect one asset (growth stock) to grow to $300,000 in 20 years with no dividends, while a bond fund produces steady taxable interest and grows to $130,000.
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Asset-location choice A (taxable: bond fund; Roth: growth stock)
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Bond interest is taxed annually in the taxable account.
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Growth stock inside Roth grows tax-free; withdrawals in retirement are tax-free.
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Asset-location choice B (taxable: growth stock; Roth: bond fund)
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Selling growth stock in taxable account later triggers capital gains taxes that reduce after-tax proceeds.
Result (qualitative): Choice A is typically superior because it avoids taxation on the large appreciation inside the Roth, while the interest-bearing bond fund’s annual tax drag is contained in the taxable account (where municipal bonds or tax-efficient bond strategies may mitigate the drag).
Illustrative arithmetic (simple): If the taxable account realizes a net tax drag of 20% on the $30,000 gain from the bond fund but the Roth’s $200,000 appreciation is tax-free, the Roth placement delivers higher after-tax accumulation. Exact outcomes depend on capital gains rates, your tax bracket, and holding period.
Example B — Corporate bond fund vs. municipal bonds
- Scenario: You have $50,000 of municipal bonds and $50,000 of corporate bonds.
- Better placement: Municipal bonds often belong in taxable accounts because their coupon interest is typically federal tax-exempt; corporate bond interest (ordinary income) often is better in tax-deferred accounts.
Real-world, mixed-account scenarios
1) Early-career investor with 401(k) + brokerage
- Keep low-cost, high-growth ETFs or individual growth stocks inside Roth/401(k) if you expect large future appreciation. Place tax-efficient index funds in taxable accounts for flexibility and favorable long-term capital gains treatment. Hold high-yield bonds or REITs (which produce ordinary income) in the tax-deferred 401(k).
2) Pre-retiree with large taxable gains and traditional IRA
- If you have a large traditional IRA and a sizable taxable brokerage account, prioritize moving income-producing, high-turnover assets into the IRA. Consider Roth conversions for concentrated positions if it fits your tax plan, balancing current tax cost against future tax-free growth.
3) Investor with municipal bond ladder in taxable account
- Municipal bonds are usually best kept in taxable accounts to retain federal tax-exempt status. Don’t move them into tax-deferred accounts unless state or other factors change the equation.
Step-by-step checklist to evaluate asset location for your portfolio
- Inventory accounts and holdings: list each account type and the assets inside.
- Identify the tax nature of each holding: interest, qualified dividends, nonqualified dividends, capital gains, or tax-exempt income.
- Rank holdings by tax inefficiency (highest-taxed first: ordinary income-producing assets → less-taxed gains → tax-free growth).
- Run a basic scenario comparison: project pre-tax returns and apply your expected tax treatment to estimate after-tax balances in 5/10/20 years.
- Consider non-tax factors: liquidity needs, required minimum distributions (RMDs), employer plan restrictions, and fees.
- Revisit annually or after significant life/tax-law changes.
Tools: A simple spreadsheet that applies your marginal tax rate to projected ordinary income and an assumed capital gains tax rate to realized gains is usually sufficient for first-pass decisions.
Common mistakes and misconceptions
- Treating asset allocation and asset location as the same thing. Allocation is about mix of stocks vs bonds; location is about where those assets live for tax purposes.
- Ignoring turnover and distributions. Two funds with the same asset class can have very different tax footprints.
- Overlooking municipal bonds: keeping muni bonds inside tax-deferred accounts can forfeit their federal tax benefits.
- Failing to factor in future tax-law changes, state taxes, or RMDs.
Useful links and further reading
- For a deeper dive on asset location techniques, see our guide: Tax-Aware Asset Location Strategies.
- To align location choices with overall portfolio strategy, read: Building a Tax-Efficient Asset Allocation.
External authoritative resources:
- IRS Publication 550, Investment Income and Expenses: https://www.irs.gov/publications/p550
- IRS Publications on IRAs (Pub 590-A and 590-B): https://www.irs.gov/retirement-plans
Key takeaways
- Asset location is a repeatable, high-impact step to improve after-tax returns—distinct from asset allocation.
- Place ordinary-income-producing assets (corporate bonds, certain REITs) in tax-deferred accounts when possible.
- Favor holding taxable-efficient equities and municipal bonds in taxable accounts; use Roth accounts for assets with high expected appreciation.
- Run simple after-tax projections before making major moves and review annually.
Professional disclaimer: This article is educational only and does not constitute tax, legal, or investment advice. Rules for taxation, IRAs, and retirement accounts change; consult a qualified tax advisor or financial planner for recommendations tailored to your situation.
Author note: In my practice working with mixed-account clients, careful asset location planning routinely reduces annual tax drag and improves retirement outcomes. Results vary with individual circumstances and tax rules.
