So you’re ready to save and invest in your future. You might have opened up a taxable brokerage account, a traditional IRA or 401k, and you have a Roth IRA. Well, now what? What do you invest in, and where? There are two strategies that you need to think about to help in determining how you invest the dollars in each of those accounts – asset allocation and asset location.
Asset Allocation
The situation that we just described is fairly common amongst the younger generation that is now making enough money to start investing. Asset allocation and asset location are important to think through, as this can have a sizable impact on your net worth in the long run. Asset allocation involves dividing your investments among different assets, such as stocks, bonds, and cash. The asset allocation decision is a personal one, and will change over time as your life changes, depending upon how long you have to invest and your ability to tolerate risk.
If you are young and have several years before retirement, you can take on a slightly more aggressive portfolio compared to an individual that is closing in on retirement and should reduce risk. For most young professionals, you’ll deploy a portfolio that has mostly stocks. An 80/20 portfolio is a great example of this strategy. What it means is that 80% of your portfolio will be in stocks, while 20% of your portfolio is in fixed income.
As you near retirement, the portfolio should reduce risk by lowering the stock percentage and increasing the fixed income. Therefore, a portfolio near retirement could be 60% in stocks and 40% in fixed income. Whatever asset allocation you go with, apply it to your overall portfolio. It’s extremely important to stay disciplined to your desired allocation and don’t try to time the market. Lastly, rebalance the portfolio when asset classes stray from their tolerance bands.
Asset Location
Asset location refers to where you strategically keep the money you’re investing, between tax advantaged, tax-free, and taxable accounts in order to maximize after tax returns. Assets that have a greater potential for growth should be located in your tax-free accounts, such as your Roth IRA. An example of this would be investing your Roth account with a heavier percentage of growth stocks, as these have a potential for higher returns compared to other asset classes.
Your tax deferred account, such as your traditional IRA or 401k, is a great account to keep income-producing investments, such as bonds or even dividend-paying stocks. Bonds will continually produce interest, which would be taxed if held in your taxable account. However, you can defer that tax payment by keeping in the IRA or 401k.
Lastly, in your taxable brokerage account, which is an account where you pay taxes on any interest, dividends, or capital gains that are realized in that current year.The tax-related goal with this account is to keep assets where we can manage the tax burden in this account. We can pick and choose when we realize gains and losses.
Asset allocation and asset location are two great strategies that can help increase your net worth if applied to your portfolio. If you need assistance with financial plans including portfolio management, give us a call.
For informational purposes only. Not intended as investment advice or a recommendation of any particular security or strategy. Past performance is not indicative of future results. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of writing and are subject to change without notice. For more information about Wealth Dimensions, including our Form ADV Part 2A Brochure, please visit https://adviserinfo.sec.gov or contact us at 513-554-6000. Please be advised that this material is not intended as legal or tax advice. Accordingly, any tax information provided in this material is not intended and cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.