Smarter Bear Newsletter #3
Asset location matters too.
Most investors are familiar with Asset Allocation - how a portfolio is divided among stocks, bonds, and other asset classes. Asset location deals with where the various assets are held - taxable accounts, tax-deferred accounts (401k, IRA), and tax-exempt accounts (ROTH IRAs and ROTH 401ks). There are 2 factors to consider in deciding Asset location - tax efficiency and expected returns. Tax-efficient investments are so-called because they aim to deliver little or no taxable capital gains or taxable dividend income. In general tax-efficient investments such as stock index funds, tax-free bond funds and investments with low expected returns should go into taxable accounts while tax-inefficient assets such as taxable bond funds and other income-producing assets are best held in tax-deferred. Assets with high expected returns are best held in tax-exempt accounts. The exact strategy depends on an investor's personal situation. Research from several large Mutual Fund companies indicates that a properly executed Asset Location Strategy can reduce lifetime taxes paid on investments by up to 20%.
Receipts to save
If you are a homeowner when you sell your house there is a nice exclusion from the capital gains due on the sale. If you have lived in the house for 2 or the previous 5 years a married couple can exclude $500,000 and a single person can exclude $250,000. Even if you aren’t considering selling your house now, you will want to plan ahead to reduce the taxable gain on your house if it has or will appreciate. Save the receipts for capital improvements you make to the house over the years. This can include a new roof, adding a deck, etc. Those capital improvements increase the cost basis of the house and thus reduce the taxable capital gain.
State tax-efficient investing
Mutual funds or ETFs (Exchange Traded Funds) which invest exclusively and directly in assets such as Treasury bonds, notes, and bills will produce dividend income free of state and local taxes. However, income from assets such as Treasury repurchase agreements ("repos") is taxable at the state and local level. Look carefully at the fund prospectus to know what you are getting. The fund’s name could give a hint - funds with "Treasury" in the name are most likely producing state tax-exempt income and "Government" in the name are likely not producing state tax-exempt income.
Smarter Bear is always available for a no-cost, initial consultation to answer questions and discuss whether our services can help with your needs. You can reach us at smarterbear.net. We also offer no-cost second opinions for people who are DIY or working with another investment or financial advisor.
We write our own newsletter, so we know these topics well. Many advisors and firms employ marketing departments, generative AI, or third-party content services to produce their newsletters.
If you know others who would like to be added to our list, feel free to add them. We aim to write short, helpful, and easy-to-read items on financial topics of interest. We welcome any suggestions for topics to cover in future newsletters.
None of the above is intended as a substitute for tax or legal advice. Your personal situation will determine what's best for you and we recommend that you consult with an appropriate professional advisor.