Asset Location - Why are My Accounts Performing Differently? [video]

transcript

So here's a common question I'll get from someone who went through the planning process maybe a year or two ago. They're looking at their account statements and wanting to know - Linda, why are my accounts performing differently? Maybe - my account is performing this way, my spouse's is doing so much better, should I just move into her funds?

Why accounts perform differently

We looked at things with an overall perspective, your overall portfolio, and we purposely set things up certain ways. When accounts are performing differently, clearly it is because their composition is not the same. One account that's mostly in stocks is going to perform and differently than an account that is mostly bonds. Why would we do things this way?

Reasons to invest accounts differently

Well, you may have different risk tolerances for different pots of money, different holding periods, or maybe we're facing restrictions somewhere. An example of that would be with the 401K. You typically have a limited list of options that you can choose to invest in, unless you have a self-directed brokerage. Most people don't have that option. So if the list of 401K options is not great, maybe there's one we liked, we'll pick that one, and then we'll round out the portfolio using the rest of the accounts.

Another reason is that you want to be as tax-efficient as possible. And this is the shift in thinking for many people. Many people that come to me that have never had a plan before have the same target date funds in all of their accounts, or their accounts are invested as mirrors of each other. So each account has the same composition, same allocation, same funds, so they are used to seeing the accounts perform exactly the same.

The benefits of asset location

Once you start having different types of accounts, we need to be aware of the tax piece and this concept called asset location. There's different types of accounts that we can use to hold and invest our money. Each of those types of accounts have different tax characteristics, and we can use those differences to our advantage.

For example, your 401k and your IRA - when those accounts generate income, you're not receiving a 1099-MISC at the end of the year to go on to your tax return, right? That income is tax deferred, so you're not paying taxes on those accounts until the money comes out and they will be taxed at ordinary rates.

Now, this is different for taxable accounts. With those types of accounts, you are paying tax on the income generated every year. You also have the ability to claim losses, donate highly appreciated stock, potentially pay more favorable tax rates when you sell at a gain.

So it makes sense to put in the taxable accounts assets that have the potential for high appreciation but generate less taxable income. Likewise, it makes sense to put assets that generate more taxable income in the tax deferred accounts.

With the Roth money, that's typically the last pot of money that we're going to touch. It grows tax free, it comes out tax free, it's a great asset for kids to inherit, if that's something that you're interested in. It makes sense to put assets that have the potential for high appreciation but are less tax efficient in the Roth accounts.

You want to have a thought out investment process that's going to look at all of these considerations and look at your entire pot of money, all the types of accounts, and put what makes sense where. But yes, that means that accounts are not going to behave the same and that's not necessarily a bad thing. My name is Linda Rogers, Owner of Planning Within Reach.

Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients throughout San Diego county and nationwide. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.

Planning Within Reach, LLC (PWR) is a fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services in San Diego and nationwide. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.