It’s a phrase you hear all the time in real estate. The idea is simple: two houses can have similar characteristics, but their location can dramatically affect their value and usefulness. A similar concept exists in financial planning. It’s called asset location, and it can be just as important as the investments themselves.
When most investors think about their portfolio, they focus on what they own. They compare mutual funds, ETFs, individual stocks, bonds, alternatives, etc., and determine their appropriate mix of investments. Those decisions certainly matter, but an important piece of the conversation is often overlooked. Where are those investments being held? The answer to that question can have meaningful implications for taxes, retirement income, estate planning, and long-term wealth accumulation.
Asset location refers to placing investments in the most appropriate type of account. Generally speaking, most investors may own assets across three primary account types: pre-tax accounts, such as traditional IRAs and 401(k)s; Roth accounts, such as Roth IRAs and Roth 401(k)s; and taxable brokerage accounts, including individual and joint accounts. While the investments held within each account may look identical, the way they are taxed and accessed can be very different when it comes to portfolio income or withdrawals.
Because each account type comes with its own set of tax rules, withdrawal rules, and planning opportunities, asset location often becomes much more of a financial planning decision than an investment decision. For example, someone hoping to retire at age 55 may have very different asset location considerations than someone planning to work until 70. A family focused on leaving wealth to children may approach asset location very differently than someone intending to spend the majority of their assets during retirement. Likewise, an individual concerned about future tax rates may make decisions unlike those of someone primarily focused on generating current income.
In practice, asset location is less about finding a single correct answer than about coordinating account characteristics with household goals. The same investment can play a different role depending on whether the priority is tax deferral, tax-free growth, current liquidity, retirement income, estate planning, or future flexibility.
One commonly discussed asset location strategy involves placing investments with higher growth potential inside Roth accounts. The rationale behind this approach is straightforward. If an investment experiences significant appreciation over time, that growth can potentially be withdrawn tax-free from a Roth account, assuming applicable requirements are met. The more growth that occurs within the Roth account, the more valuable that tax treatment becomes.
Perhaps the most famous example is Peter Thiel’s Roth IRA. While PayPal was still in its infancy, Thiel reportedly purchased founder shares within a Roth IRA for a relatively small amount. At the time, it was a speculative investment with substantial risk. Few people could have predicted the eventual outcome. As PayPal grew and Thiel’s holdings appreciated, the value inside that Roth IRA reportedly expanded into the billions of dollars. Though most investors will never experience anything remotely resembling that outcome, the example highlights a broader principle rather than a repeatable strategy. When meaningful growth occurs inside a Roth account, the potential tax benefits can be substantial.
Of course, asset location isn’t only about growth. It is also about understanding how different investments are taxed along the way. Certain investments generate taxable income on a regular basis. Bonds may produce interest income, REITs often distribute income to shareholders, and some alternatives can generate highly tax-inefficient cash flows. For example, a hedge fund exposure may generate substantial short-term gains, which are taxed as ordinary income. When these investments are held in a taxable account, they can create an annual tax liability regardless of whether the investor actually spends the income. In some situations, it may make sense to hold these assets inside a tax-deferred account, whether that is a traditional or Roth IRA, where that income may continue compounding without creating a current tax bill.
At the same time, there can be advantages to maintaining certain investments in a taxable brokerage account. Unlike retirement accounts, taxable accounts generally provide unrestricted access to capital. This flexibility can be particularly valuable for individuals retiring before age 59½, navigating a career transition, funding a major purchase, or simply maintaining a larger emergency reserve. While taxable accounts often receive less attention because they lack some of the tax benefits associated with retirement accounts, their accessibility can make them an important component of an overall financial plan.
Asset allocation determines what you own. Asset location determines where you own it. Both inform long-term, after-tax total returns. Two investors could own the exact same investments and, purposefully or not, experience very different outcomes simply because those investments were distributed differently across their accounts. Given that potential, we generally seek to coordinate allocation and location decisions as we help clients develop and address their financial objectives. Ultimately, there are no universal formulas that work for everyone; potentially appropriate strategies will depend on a wide range of factors specific to the household.
We find that investors often devote enormous amounts of time and energy trying to identify the perfect investment. Far fewer seem to spend the same amount of time considering where that investment should actually be held. Yet over the course of decades, decisions about where you hold your investments can have a meaningful impact on your flexibility, tax burden, and the amount of wealth you ultimately retain.
