Where you hold investments matters as much as what you invest in. The same investment in different accounts can have wildly different after-tax returns.
The Core Principle
Tax-inefficient investments → Tax-advantaged accounts Tax-efficient investments → Taxable accounts
This is called "asset location."
What Makes Investments Tax-Inefficient?
| Characteristic | Why It's Inefficient |
|---|---|
| High dividends | Taxed annually |
| Interest income | Taxed as ordinary income |
| Frequent trading | Short-term gains |
| Non-qualified dividends | Taxed at higher rates |
Tax-inefficient examples:
- Bonds and funds
- REITs
- High- stocks
- Actively managed funds
What Makes Investments Tax-Efficient?
| Characteristic | Why It's Efficient |
|---|---|
| Low/no dividends | Less annual taxation |
| Low turnover | Fewer capital gains |
| Qualified dividends | Lower tax rates |
| Long-term holds | Long-term cap gains rates |
Tax-efficient examples:
- Total market
- Growth stocks
- Tax-managed funds
- Municipal bonds (in taxable)
The Asset Location Strategy
Tax-Advantaged Accounts (401k, , )
Put here:
- Bonds and bond funds (BND, AGG)
- REITs (VNQ)
- High-dividend stocks
- Actively traded funds
Growth is tax-deferred (Traditional) or tax-free (Roth/HSA).
Taxable Brokerage Accounts
Put here:
- Total funds (VTI, ITOT)
- International stock funds (VXUS)
- Growth-oriented ETFs
- Tax-managed funds
- Municipal bonds
These generate fewer taxes annually and qualify for lower long-term capital gains rates.
Example Portfolio
Target allocation: 70% stocks, 30% bonds
Total: $200,000
- 401k: $100,000
- : $50,000
- Taxable: $50,000
Tax-efficient approach:
- 401k: 100% bonds ($100,000)
- Roth IRA: 100% stocks ($50,000)
- Taxable: 100% stocks ($50,000)
Result: 75% stocks, 25% bonds (close to target) All bonds in tax-advantaged; all stocks in accounts where they're most efficient.
Roth Placement Strategy
Pro Tip
Put your highest-growth investments in Roth accounts. Growth is tax-FREE forever.
| Account | What to Prioritize |
|---|---|
| Traditional 401k/IRA | Bonds (tax-deferred) |
| Roth 401k/IRA | High-growth stocks (tax-free growth) |
| HSA | High-growth stocks (triple tax-free) |
| Taxable | Tax-efficient stock funds |
When Asset Location Matters Most
| Situation | Impact |
|---|---|
| Large taxable account | High impact |
| High | High impact |
| Long time horizon | High impact |
| Small accounts, low bracket | Lower impact |
The benefit compounds over decades. A 0.5% annual tax savings becomes massive.
Common Mistakes
Avoid This
- Holding bonds in taxable accounts
- Holding REITs in taxable accounts
- Ignoring asset location entirely
- Over-optimizing small accounts
- Forgetting to consider state taxes
Quick Win
Review where your bonds are held. If they're in a taxable account, consider moving them to your 401k or IRA during your next rebalance.