If you are in a position to benefit from an asset location strategy, you have to choose which assets to assign to your tax-advantaged accounts and which to leave in your taxable accounts.
In general, the following are higher on the tax-advantaged scale:
- Individual stocks are, as a general rule, relatively tax-advantaged if bought and held for longer than a year.
- Equity index mutual funds and ETFs are generally quite tax-advantaged.
- Tax-managed equity funds (that is, equity funds that name tax management as an explicit goal) tend to be highly tax-advantaged.
- Bonds and bond funds (with the exception of municipal bonds and funds, and US Savings Bonds) are generally highly tax-disadvantaged, because they generate interest payments that are taxed at relatively high ordinary income rates. Potentially higher returning types of bond investments, such as US high yield and emerging markets bond funds, are the most tax-disadvantaged.
- Actively managed stock funds with high turnover rates are less tax-advantaged because they tend to have high rates of capital gain distributions. They sometimes even distribute short-term capital gains, which are taxed at the higher ordinary income tax rates.
So, which investments do you put where to help enhance after-tax returns? See next blogpost for the answer.