Supercharging Your Investments: Asset Location

Supercharging Your Investments: Asset Location

Looking for a better way to allocate your assets in your portfolio? Check out this concept of asset location to strengthen your return on investments.

You may be familiar with asset allocation but did you know asset location takes it a step further? Instead of just allocating investments in different areas (i.e. bonds, cash, stocks), it's important to choose where they are located: personal account or an IRA.

Asset Location

Let's assume you have $2 million in investments that are split between your personal account and IRA:

◦$1 million in the personal account◦$1 million in the IRA

Prime Example

Personal account investments are subjected to taxes on:

◦Bond interest◦Stock dividends◦Taxes on capital gains from the sales of bonds and

stocks

Personal Account

IRA investments are not subjected to taxes, which means there isn't income or capital gains taxes

*This example is focusing on the accumulation/pre-distribution phase; the IRA account will be taxable when you turn 70 1/2 years old on the required minimum amount*

IRA Account

Let's assume your overall asset allocation of all the accounts makes up 40% of bonds and 60% of stocks.

40/60 Split

Government/Corporate bonds: generally yield higher interest rates but the interest is taxable.

Municipal bonds: generally yield a lower interest rate but the interest is tax-free.

Types of Bonds

Which bonds do you buy in your personal account and which do you buy in your IRA?

Question

Peter Culver suggests you use the personal account to buy municipal bonds since they are tax-free, and use the IRA to buy government/corporate bonds because they will also be tax-free when purchased with the IRA.

Answer

Using the 40% bonds allocation, a $2 million portfolio will account for $800,000 in bonds.

◦ IRA will share $400,000 of government/corporate bonds◦Personal account will share $400,000 of municipal bonds

The Numbers

Looking at historical data, the government/corporate bonds will yield an annual rate of 5% and the municipal bonds will yield an annual rate of 4%.

Historical Data

These numbers will help you understand the total annual interest that is tax-free:

Personal Account: $400,000 @ 4% $16,000 annual interestIRA Account: $400,000 @ 5% $20,000 annual interestTotal: $36,000 annual interest

Outcome

If you had purchased government/corporate bonds in your personal account, the after-tax yield would be 40% because of the 40% income tax on government/corporate bonds need in a personal account.

See what a difference asset location can make!

Benefits Of Asset Location