How To Increase Returns With Strategic Asset Location (And What To Avoid)

Did you mean asset allocation ? And the answer is no . Asset allocation is essentially how you're invested . Asset location tells you what types of accounts hold your different investments .

So many of you listen to the podcast and you're saving and you're investing well , and you're going Ari , i've got a Roth IRA , i've got a 401K , i've got a brokerage account because I've heard your podcast and it's really helpful to retire early with that account And I'm going yes , you're right , but should I invest the exact same way in all of those ?

That's what a lot of people ask , And the answer is no , so I'm going to go over that today . One the things you should not worry about , the things not to think about so often , and here's 100 things to make sure you do well to get your finances in order . Often times , that's helpful . Sometimes , though , i want to say Hey guys .

Here are five things to please do not worry about . You might hear this and go , wow , i've only got a 401K , so this is what applies to me . Or I've only got a brokerage account not too much in my Roth , so I'm not going to worry about what Ari said right there . My job is to make finances easier , not more complicated , so I'm going to go over this .

Today There was this episode excuse me , was prompted by a listener question , so this was coming from Lewis , and Lewis says Ari , love the podcast , appreciate the work that you put in . I like the detail . I have a question How can I be sure I'm investing well ? I own what I hear are good investments from my reading , but I have different accounts .

Do they all go equally in each account , meaning do I put each investment the exact same into each account , or how should I look at this ? I want to retire early at 61 . I recently had a health scare . Thanks again . So , lewis , thanks again for your question . This is a very common question And I hope everything on the health end is okay with you .

Lewis , i know that is not fun . Not too much of a tangent here . I'm going to get into today's episode , but I want you all to know . I often receive emails from clients , and a client just emailed me today .

He said Ari , my sister had a recent health scare and it turns out it's genetic And because of that I'm thinking differently about my retirement and I'm going to go to the doctor and get checked . And what clients will often tell me is they'll say Ari , ignorance is bliss and I'm scared , i don't know how long I'm going to live .

It's never fun to even think about this , but when it happens to an immediate health member , i want the next soonest appointment with my doctor . So , once again , don't let this be . This is not going to become a medical podcast , but if you guys are going , you know what ? There's an appointment I've put off for some time . I kind of just don't want to know .

Let this be your soft invitation for lack of a better phrase to go make that appointment And , at the very least , if you get some feedback which sometimes isn't always fun of , hey , this is what you're on track for . If we don't change lifestyle , then the reality is you're going to be projected to live till XYZ .

Now , nobody ever knows , of course , but the value of doing something like that is you can go wow , if that's the reality here , what can I do today to make sure I'm spending my life the way I want to spend it ? So I'm going to kind of get off that tangent .

But it's very important and very easy to gloss over that and go back to the finances , because it's easy to save and invest more . It's actually more fun to do so . You can see the values grow . It's actually harder to look at life and go , okay , what changes can I make to live the life I want to make ?

So I'll stop on that end for now and get back to today's episode And I will real quick just go over . Of course I like to go over the most recent reviews that have come in from the show . I do appreciate when all of you guys do leave those reviews . This one comes from Chicken Nugget Eater 4262 . That is quite the name there .

I must love Chicken Nuggets . It says Remind Me of Dave Ramsey Great podcast . Remind Me of Dave Ramsey's podcast Great information to learn about financial freedom and how to prepare for retirement . Another review comes in from Matt00 .

This podcast intrigued me and showed me the possibilities to start your retirement earlier , sooner than others , with small steps and consistency . So thank you once again for those reviews . The more that you guys leave reviews , the more people that can find the show .

Over 360 ratings and so many downloads every month because of you guys helping more people retire early . So could not do any of this without you guys . So I appreciate the support and hope that it is helpful . Once again , i love hearing your feedback .

So go to my website if you want me to , of course , reply to your question or if you want to work with me . So let's hop into today's episode Asset location , asset allocation How are we going about this ? Once again , asset location sounds just like asset allocation , but they are indeed very different . Asset allocation tells you how you are invested .

Asset location tells you what types of accounts hold your different investments . So , practically speaking , asset allocation that's what you all have right now , whether you know it or not . That's going to determine the return that you expect to receive . Asset location is going to determine how much of that return you're actually going to keep after taxes .

So many of you guys have already heard my bad joke , but my bad joke is I'm all about being patriotic , not to the point . You pay more in taxes than you need to . So that cliche saying if it's not what you make , it's what you keep . That's what asset location is saying . How can we actually implement that saying ? So what makes up your return ?

How do you make your money ? Well , when you're investing , there's interest , there's dividends and there's capital gains . Now , to make it extra fun , all three of those interest , dividends and capital gains are taxed differently . They do that because they want to make it as confusing as possible . Just kidding .

That's not why they do that , but they're all taxed differently . So interest , that's taxed like ordinary income . What does ordinary income mean ? It's as if you just made more money . So federal taxes , between the 10% and 37% bracket , that's ordinary income . Those are federal brackets . Now , dividends if it's non-qualified , it's taxed like ordinary income .

So it's just what I said before with interest , it's as if you just made more money . Qualified dividends , those are taxed like capital gains . So that's between 0% and 20% federally . Now it could also be subject to the net investment income tax , but we're going to just keep it simple for today . Capital gains .

So I just went over interest , ordinary income , dividends , the non-qualified portion , ordinary income , the qualified capital gains , and then , if we actually just look at capital gains , the short-term portion , which means if you held it for under a year any position you buy Apple stock , you put $1,000 in . It grows to $10,000 .

You hold it for underneath a year , even if it's 364 days , that will be taxed as ordinary income if you sell it . So that whole gain of $9,000 , that's taxed as if you just made more money . But if you held it one more day , it's taxed long-term , which is likely for most of you going to be at 15% . But it ranges between 0% and 20% .

So some people will go . I like that 0% . How do I get more of that ? And when people retire early or they're considering an early retirement and maybe they're doing part-time income or maybe there's a pension or social security or there's other things going on .

The reality is you have a very strategic opportunity , if you take it well , where you can actually pay 0% taxes because maybe you're working . And then there's a year where you go already . I don't know if I'm going to go back to work or you know what I am done . I'm 58 years old .

I've saved and invested well , i've got a few million dollars and now you're in a low tax bracket . What if you have significant gains ? You could , because you have low income , pay 0% taxes on a lot of those gains . So that's a tactic I'll do for a lot of my clients .

Now let's look at this simple example so you guys can understand how I'm looking at this . So let's go cheaper . Long term better , cheap and more effective Level is obvious . What are you doing To see how asset location is utilized ? let's start with this really basic example . Let's pretend you have 50% growth stocks and 50% bonds .

It's not an ideal allocation , but growth stocks on average they don't pay much in dividends . Most of the growth is coming from capital gains . but besides the point , bonds if you hold them to maturity and they're not sold for a gain or loss before , then all of the growth comes from interest . So don't hear this going already .

That's an allocation you're recommending . I'm going to do that . Don't do that . This is just so you can understand the point here . So let's say you have an IRA .

If you have an IRA , i want you to ignore almost everything I just said , because if you're in a tax deferred account , you don't have to worry about selling next day or a year from now , or five years or 10 years from now . It's just when you eventually pull the money out . That's when we have to think about taxes .

But for now , ira , roth IRA you make any changes in there , don't worry about it . With your brokerage account , we need to be intentional . So check this out . Let's say you have an IRA and a brokerage account And you know that on average growth stocks are going to go up 10% per year , but you don't have to pay any taxes if you don't sell .

So theoretically you could be at 0% taxes . If you're holding them long term , you're just making money . You're going already . I'm being a good long term investor , wonderful . But now let's pretend you have some bonds And those bonds are paying a 4% interest rate .

If you are in a combined 30% tax bracket from federal and state , then the real return on that 4% interest rate is 2.8% . That's if you have it in a taxable account . So the first order of thinking when you're looking at this is hey , do we put any of those bonds in the IRA so that you get that full 4% return ?

Because right now , if you're looking at this example , you're putting that 4% interest rate , those bonds , into your IRA .

You'll get the full 4% return If you put it into that taxable account or the brokerage account , or the individual or the joint account , which are all the same thing , because they want to make it as confusing as possible then you're only getting that 2.8% , what we call real return , the after tax return .

So this is what I want you to think about Put those growth stocks in your brokerage account . This is , though , number one . When we're looking at asset location , the first step is to go what is the right mix of equities to fixed income , to cash .

More often than not , it's your 90% , 80% , 75% equities , and so we want to be intentional and go hey , if we have that , let's put them in the brokerage account , because we want to make sure we're being wise with this . So , once again , what should you do ? Number one understand your overall asset allocation .

Excuse me , i'm already confused with that , as you can see , what mix of different investments do you need to meet your goals ? Number two understand your withdrawal strategy . What accounts are you going to be drawing from ? first , and you can align that with asset location , which , of course , is based on two things Tax decisions .

This is where most people , by the way , they start and they finish , they go okay , there's tax decisions , got it ? I put this account here , i'm going to invest this amount in that . And that's where most people start If they're trying to do asset location . Well , what they don't do , i find , is understand not just tax decisions but the withdrawal decisions .

Because if you're going to draw down from a brokerage account first , then you probably need some bond or other short-term investment to support that . The thing is , asset location in a vacuum says put all the stocks in your brokerage account . So you're going to already . You just said two different things there .

You said just a minute ago that if I'm going to invest , i want to be really intentional about where I put things , and if I only put things that are things like bonds in my taxable account , i'm not taking as much home . I'm going to put that in the IRA , but then you're going already .

You also just said that asset location in a vacuum says to put all of the stocks in your brokerage account . So those are two different things And I'd be going . Yes , you listening to this . You are correct .

That location , when looked at comprehensively , should absolutely consider the tax implications , but don't neglect the withdrawal decisions , because if , from a tax perspective , you do everything right from what I just said , what you would do is , you would put all of the stocks in your brokerage account . But then guess what ?

What if markets come down significantly And you're going already ? these were my safe assets . I was supposed to live on from the tax perspective . I feel like I did the right thing , but now look what happened . My portfolio is down 20 , 30% . Oh no , that's what we're trying to avoid here .

So , yeah , let's be wise with the taxes , but let's not let the tax tail weigh all the financial plan dog , and I'm going to let you guys make fun of me for that saying I'm okay with that If you put all your stocks in the brokerage account and once again , stocks are down when you have to withdraw them .

Well , the reality is , how many years or even decades of tax savings did you just wipe out by neglecting that second and often overlooked aspect of asset location ? So you're not going to go wrong . You don't have to worry , because here's the example of where people go wrong and why it's not going to happen to you . I'm going to tell you what not to do .

Roth is tax free , so therefore , when we look at Roth accounts , i don't want any bonds in there . Even though we would be avoiding taxes . Some people go . We should put all of our bonds in our Roth . We're going to avoid taxes . But let's look at this example . Let's say that you have 250,000 in a Roth IRA when you retire at age 62 .

Fast forward 15 years , so now you're 77 . Assuming the account grew at 5% per year instead of 10% per year , like if you put it in stocks . Well , the Roth account that grew from 250,000 to 520,000 , with the 5% return , versus growing to $1,000,000 plus $50,000 . So 520,000 versus a potentially $1,050,000 . That's a big difference there .

Did the asset location save you over $525,000 in taxes during that time ? Almost certainly no . So why sacrifice the $525,000 in tax-free money for just a little bit of money saved on your tax bill each year ? This is where people go wrong hearing about yes , ari , i get it , i want to save on taxes And then they'll let that be the real driver here .

I'm not saying asset allocation isn't worth it . It is . What you have to do is understand the big picture , and that's why I talk about vacuum planning .

Don't make any single decision in a vacuum , because it can sound really good in a vacuum without understanding what it actually means , and this is , as you can see , hundreds of thousands of dollars of a decision here . So don't let that tail wail the life of the financial plan dog . Once again , you can make fun of me for that .

The goal is not to have the lowest possible taxes . The goal is to have the best after-tax returns . I'm going to say it one more time The goal is not to have the lowest possible taxes , but the best after-tax return . Would you rather have a 5% gain that you pay no taxes on or a 12% gain you pay 50% taxes on ?

Obviously , we'd love the 12% with no taxes . I can already hear some of you guys saying that , but if you're given the choice , it would be foolish not to take the 12% gain with 50% taxes because after taxes it's 6% better than 5% without taxes . So hope you guys can understand through that .

You have to align the timing of when you're going to spend these funds with the asset allocation and the asset location . So a few things not to do and then I'm going to summarize it all for you Bonds in Roth . Please do not do that .

I see a lot of advisors that will do this for clients , because 80% to 90% of people that reach out to me they're coming from another advisor , 20% of the time or so , people come to me going already I've saved an invest-well , just I haven't found the right fit for me , or I've wanted to manage this on my own , or whatever the reason may be .

But most of the time they're coming to me from another advisor And so if you're doing bonds in Roth , their advisor is telling them doing this is going to save you $2,000 a year in taxes And you as a client , it's going all right . That sounds amazing , thank you , but that's significant , don't get me wrong .

But what's the cost to the total after-tax growth of your wealth over time by not investing in equities in that Roth account ? That's really what I would ask , and you can't quantify it exactly . You have to make an assumption . But I think that's where advisors go .

Well , i kind of like that I can show the client here's how much I'm saving , as opposed to showing , hey , if we invest this way and potentially get this return , this is what it might do for you , never guaranteeing , of course , but the odds are a lot more in your favor , as I just showed you through a 500,000 plus example . So It's number one .

Number two Muni bonds . Those are very good for high income or for high net worth individuals . Bonds like Munis . You don't pay taxes on the interest . So some people go great , i want 25% of my portfolio in Muni bonds .

Then what they'll do is they'll put 25% of their brokerage account in Munis , 25% in Roth IRA , 25% of IRA and just another 25% in another account And then they go . Oh my gosh , i just love this idea And the idea makes sense because you're going , i don't want to pay a lot in taxes , but remember these Muni bonds .

You don't have to worry about taxes in your Roth IRA or your IRA And because of that , we don't want to put any assets like a Muni bond , which might not grow a whole bunch but could provide good income , in something like a Roth IRA or an IRA . Number three focus on the asset location at the expense of everything else . That's where people go wrong .

So once again , these are the three things not to do . Number one bonds in your Roth account , muni bonds in Roth IRA accounts and focusing on asset location at the expense of everything else . Getting your asset allocation is going to be the real difference in significant returns over time , whether it's 8% growth , 10% , 12% , 14% .

That is really really important Asset allocation depending on the individual and their tax situation is impactful , but to a much lesser degree more often than not . So it's not saying , you know , is this podcast completely irrelevant ? It's no . This is extremely relevant .

If you're looking at your plan going , ari , my advisor doesn't have me in 100% equities in my Roth IRA . I'd go . Okay , why is that ? If you're managing your portfolio going , i want to make sure I keep taxes low .

I'm going to make sure that when I look at investing , i want to make sure all of the growth stocks are in my brokerage account , because those growth stocks will mean I'm not paying those interest taxes that Ari talked about just a moment ago . Well , what if you retire earlier and you go ? Ari , i need these funds . I just went and checked my account .

It's down a whole bunch . So now where's income going to come from ? So you just don't want to let that tax tail Once again for final sake here , whale the life or the financial planning dog . So that is it for today's episode . I hope this was helpful .

I know a little bit longer than usual , but hope that this resonates , and I probably should say this at the beginning of each episode , but the reality is you all can put this on a little bit faster speed , so I think you all know that . But I had someone reach out going . Ari , you talk a little slow for my liking and I let them know .

Hey , you can put that on . You know 1.2 or 1.5 speed And they're like Ari , i love listening to you on 1.7 speed . I go through five episodes . It's awesome . So I want you guys to make sure you're getting the most out of these podcasts .

Lastly , if you do want to work with me I've mentioned this If you're not on my newsletter already , if you haven't got my ebook already but I mentioned all of this during my episodes which is I'm going to stop taking on new clients early 2024 .

So , if you're looking to work specifically with myself or you want a custom plan with a member of my team in the future , yes , reach out , but I want to make sure I'm always giving that 100% high quality service to my current client . So hope that this was a helpful episode .

If you want to retire early , think about asset location in light of your entire financial plan . Thanks guys , see you next week . That's the first episode of the early retirement show . If you have a question that you want answered in a future episode . You can always go to my website , earlyretirementpodcastcom .

That's earlyretirementpodcastcom , and you can go ahead and submit a question that I'll look to answer in a future episode . Thank you all for listening . Please do rate it , review it and share it with someone who you think would benefit from this information . If there's anyone out there that you know , i certainly appreciate it and I will see you all each week .

Hey guys , thanks for listening . Please be smart about this . Nothing in this podcast should be construed as financial , tax or legal advice . Consult with your tax preparer or financial advisor before taking any action . This podcast is for informational purposes only .