8 Asset location
This chapter covers
- Understanding asset location
- Creating Python classes to help analyze asset location strategies
- Computing the numerical tax efficiency of different types of assets
- Quantifying the benefits of tax location
- Performing an optimization to solve a three-account problem
In chapter 2, we introduced the topic of asset allocation—the optimal weighting of assets in a portfolio. But investors hold different types of accounts, ranging from taxable brokerage accounts to tax-deferred IRAs and 401(k)s to tax-exempt Roth IRAs, and we never discussed how investors should distribute their assets among these different types of accounts. This is called asset location. Table 8.1 lists the three main types of accounts and compares their characteristics.
Table 8.1 Comparison of taxable, tax-deferred, and tax-exempt accounts
| Taxable | Tax-deferred | Tax-exempt | |
| Example | Brokerage | IRA, 401(k) | Roth IRA, Roth 401(k), 529, Health Savings Account |
| Taxation ofdividends | Taxed at either ordinary-income rate or capital gains rate, depending on whether dividends are “qualified” | Taxed as ordinary income when funds are distributed | Not taxed |
| Taxation ofcapital gains | Taxed at capital gains rate when gains are realized | Taxed as ordinary income when funds are distributed | Not taxed |