McGladrey Wealth Management LLC
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Maximizing after-tax returns
through asset location
• Asset location refers to the type of account (taxable or tax-deferred) in which an
investor should purchase and hold various types of investments with the goal
of maximizing after-tax returns.
• An effective asset location strategy should take into consideration the
individual needs of each investor, as there is no universal asset location solution
that fits all situations.
• The tax free growth offered by a Roth IRA adds a unique twist to effective asset
AUTHOR:
Daniel A. Avery, CFP®
Investment Services Director
location strategies that investors can use to their advantage.
• Investors should consider both the relative tax efficiency of different market
segments and the tax efficiency of investments within the segments
themselves.
C O N TA C T D E TA I L S :
980.233.4694
dan.avery@mcgladrey.com
• Your McGladrey Wealth Management Advisor is available to discuss and review
your asset location strategy as your situation changes over time.
Just as taxes permeate all areas of your financial wealth, tax planning permeates all areas of
McGladrey Wealth Management (MWM). We work with investors to design tax minimization
strategies to help grow and preserve your wealth.
Among the tax minimization strategies implemented by MWM is asset location. Asset location
refers to the type of account (taxable or tax-deferred) in which an investor should purchase and
hold various types of investments with the goal of maximizing after-tax returns. On Jan. 1, 2013,
the top federal tax rates on investment returns increased to 43.4 percent on most investment
income with a 23.8 percent rate applying to net long-term capital gains and qualified dividends,
adding additional importance to asset location decisions.
An effective asset location strategy should take into consideration the individual needs of each
investor, as there is no universal asset location solution that fits all circumstances. Strategies
can vary based on investor specific factors such as investment timeline, liquidity needs, and
tax situation. With this in mind, the following information is intended only to present a general
framework for making asset location decisions.
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Asset location strategies can evolve as external factors such as expected returns and bond yields change
over time. For example, traditional asset location advice has been to hold bonds in tax-deferred accounts.
This is due to the fact that bonds tend to create a high amount of income that is taxed at a rate higher
than capital gains for most investors. However, some might argue that today’s low interest rates have
decreased the amount of income received from bonds enough to make the rule of thumb less reliable.
The assumptions used here for the expected behavior of various investment types are based largely on
historical data rather than current trends, and are not designed to predict changes in the future.
The primary method for investors to benefit from asset location is identifying the least tax efficient securities
in a portfolio and allocating them to tax deferred accounts such as 401(k)s, 403(b)s, traditional IRAs, or tax
exempt Roth IRAs. Assets remaining after this initial allocation would then overflow into taxable accounts.
The chart below illustrates the relative tax efficiency of several market segments and may be used as
a priority schema for determining optimal asset location strategies. The chart has been constructed
specifically with mutual funds and exchange traded funds (ETFs) in mind. As you can see, segments
that tend to produce higher amounts of income are generally ranked as less tax efficient. This is due to
the fact that this income is taxable and often at the higher ordinary income rates. Securities that tend
to produce a higher percentage of qualified income, which is taxed at a lower rate, are ranked as more
tax efficient. Expected return is an additional factor that should be considered. However, the ability to
harvest tax losses and donate appreciated securities, the step-up in basis upon death of the investor, and
the favorable long term capital gains rate make expected return less of a factor in the rankings.
Asset location rankings by market segment for Mutual Funds and ETFs
Most tax efficient
Least tax efficient
Market segment
Expected
distributions
Percent of income
expected to be
Expected return
qualified
International Large Cap Equities*
Low
High
High
U.S. Large Cap Equities
Low
High
High
Global Equities
Low
High
High
International All Cap Equities*
Low
High
High
U.S. All Cap Equities
Low
High
High
International Small Cap Equities*
Low
High
High
U.S. Small Cap Equities
Low
Moderate
High
Emerging Markets Equities
Low
Moderate
High
Balanced Funds (Equities & Fixed Income)
Moderate
Moderate
Moderate
U.S. Taxable Fixed Income
Moderate
Low
Low
Inflation Protected Fixed Income
Moderate
Low
Low
International Fixed Income
Moderate
Low
Low
Commodities
High
Low
Moderate
Diversified Alternatives
High
Low
Moderate
Emerging Market Fixed Income
High
Low
Moderate
High Yield Bonds
High
Low
Moderate
Global REITs
High
Low
High
*International equity funds may have a small tax advantage over similar U.S. equity funds due to a potential
Foreign Tax Credit
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Taking advantage of the Roth IRA
Most retirement accounts are designed to allow for taxes on growth to be deferred until the point when
withdrawals are made. The characteristics of a Roth IRA add a unique twist to effective asset location
strategies that investors can use to their advantage.
In general the expected income and percent of that income that is expected to be qualified are more
significant factors than the expected return as it relates to ranking tax efficiency. While this approach
can be suitable for the Roth IRA as well, investors may benefit by paying special attention to the
expected return for this type of retirement account.
In addition to tax deferral, Roth IRAs also allow for qualified tax free withdrawals. This feature effectively
allows for an infinite amount of tax free appreciation within the account. Investors should consider
allocating investments that have relatively high expected total return to a Roth IRA to best take
advantage of this feature.
Consider an investor allocating the six market segments shown in the following chart between
Traditional IRA, Roth IRA, and taxable accounts. In an attempt to maximize the benefit from the Roth
IRA, the investor bypasses the Balanced Fund segment with a lower overall tax efficiency ranking for
the Emerging Markets Equities segment with a higher expected return. U.S. Large Cap Equities and U.S.
Small Cap Equities also have high expected returns, but are allocated to the taxable account given their
higher overall tax efficient rankings.
Roth IRA asset location example
Most tax efficient
Least tax efficient
Market segment
Expected return
Account
U.S. Large Cap Equities
High
Taxable
U.S. Small Cap Equities
High
Taxable
Emerging Markets Equities
High
Roth IRA
Balanced Funds (Equities & Fixed Income)
Moderate
Taxable
U.S. Taxable Fixed Income
Low
Traditional IRA
International Fixed Income
Low
Traditional IRA
This is only an example of how an investor might attempt to take advantage of the unique characteristics
of a Roth IRA and isn’t suitable for everyone. Investors should consider their own individual circumstances
and consult with their advisor when developing an asset location strategy.
Beyond the basic framework of the relative tax efficiency of different market segments, there are
additional considerations which may factor into asset location decisions. In fact, the tax efficiency of
investments can vary greatly not only by segment, but within the segments themselves. This can be
due to a number of factors including management strategy, trading strategy, amount of turnover, and
even the behavior of other investors in pooled vehicles. The following chart names a few investment
characteristics that can play a role in determining the relative tax efficiency of investments within each
market segment.
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Guidelines for tax efficiency within each segment
More tax efficient
Less tax efficient
Passively managed
Actively managed
Tax-managed
Non tax-managed
Lower turnover
Higher turnover
Lower % ordinary dividends
Higher % ordinary dividends
Higher % qualified dividends
Lower % qualified dividends
Lower expected return
Higher expected return
Lower yield
Higher yield
Long-term capital gains
Short-term capital gains / interest
Conclusion
Considering the general characteristics of various investments can provide a good starting point for
determining an effective asset location strategy. However, since there is no single optimal asset location
strategy for every situation, it is important for investors to also consider their own unique needs.
McGladrey wealth management advisors are available to discuss and review your asset location strategy
in an effort to maximize after-tax returns as your situation changes over time.
800.274.3978
www.mcgladrey.com
This document contains general information, may be based on authorities that are subject to change, and is not a substitute
for professional advice or services. This document does not constitute assurance, tax, consulting, business, financial,
investment, legal or other professional advice, and you should consult a qualified professional advisor before taking any
action based on the information herein. McGladrey LLP, its affiliates and related entities are not responsible for any loss
resulting from or relating to reliance on this document by any person.
Tax and accounting services are provided by McGladrey LLP, a registered CPA firm. Investment advisory, financial planning
and other wealth management services are provided by McGladrey Wealth Management LLC, an SEC-registered investment
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