United States
Hong KongAsset location: which account holds which asset
Tax-inefficient assets - bonds, REITs, high-turnover funds - generally belong in tax-deferred accounts. Tax-efficient assets and those with the highest expected growth belong in taxable and Roth accounts respectively.
Asset allocation decides what you own. Asset location decides which account holds it, and it is one of the few genuinely free improvements available.
The three account types
| Account | Treatment |
|---|---|
| Taxable | Income and realized gains taxed annually; step-up in basis at death |
| Tax-deferred | No tax until withdrawal, then ordinary income; required minimum distributions apply |
| Roth | No tax on qualified withdrawals; no lifetime required distributions for the original owner |
Everything about location follows from those three rows.
The general ordering
- Tax-deferred - taxable bonds, REITs, high-turnover active funds, anything throwing off ordinary income.
- Roth - the highest expected return assets, because growth is never taxed and there are no lifetime required distributions.
- Taxable - tax-efficient equity index funds and ETFs, municipal bonds, and holdings intended to pass at death with a step-up.
The Roth logic is worth stating: putting the fastest-growing asset where growth is permanently untaxed maximizes the value of the Roth wrapper. Putting a bond fund there wastes it.
The overall allocation is set first, across all accounts together. Location then places the pieces. A question that changes the allocation to achieve better location has the priority backwards.
The exceptions
Municipal bonds belong in taxable accounts, never in tax-deferred ones. Their advantage is tax-exempt interest, which is worthless inside an account where nothing is taxed anyway - and it converts to ordinary income on withdrawal.
Assets with large embedded losses belong in taxable accounts, where the loss can be harvested. Inside a retirement account a loss is simply gone.
And a client with a short horizon or a liquidity need has constraints that override the general rule.
The other tax-efficiency levers
- Holding for more than a year to get long-term capital gains treatment.
- Harvesting losses, observing the thirty-day wash sale rule.
- Preferring low-turnover funds in taxable accounts.
- Specific identification of lots when selling, rather than accepting a default method.
- Donating appreciated holdings to charity rather than selling and donating cash.
The last is the most underused. Donating an appreciated holding held more than a year gives a deduction for fair market value and avoids the gain entirely.
Why it is worth doing
Location changes after-tax return without changing risk. Nothing else in the investment domain offers that, which is why questions treat it as a clear right answer rather than a judgment call.
Dollar limits and rate thresholds here are indexed annually. Confirm the current figure before relying on it, and expect the exam to test the rule rather than the number.
Common questions
What is asset location?
Deciding which account type holds which asset, after the overall allocation is set. It improves after-tax return without changing risk.
What belongs in a tax-deferred account?
Tax-inefficient assets - taxable bonds, REITs and high-turnover active funds - because they generate ordinary income that would otherwise be taxed annually.
What belongs in a Roth?
The highest expected return assets, because growth is never taxed and there are no lifetime required distributions for the original owner. Putting a bond fund there wastes the wrapper.
Why should municipal bonds stay in a taxable account?
Their advantage is tax-exempt interest, which is worthless inside an account where nothing is taxed anyway - and it becomes ordinary income on withdrawal.
Does location come before allocation?
No. The overall allocation is set first across all accounts together, and location places the pieces. Changing the allocation to improve location has the priority backwards.