Location, Location, Location


Generally this phrase is used in relation to the value of real estate, but it can have important implications for regular investment accounts as well.  Understanding how to efficiently utilize asset location strategies is the one freebie we have in investing.  What I mean by this is that is that investors can increase their wealth over the long run while taking on no additional risk and paying no additional cost.  In fact, it doesn’t require making any changes in what one is investing in at all.  While this may sound cryptic and complex, it’s actually a very simple idea, given an investor meets two specific requirements:

  1. They have money invested both pre-tax (IRA, 401K etc.) and after-tax (Roth)
  2. They have some money in more growth oriented investments (Stocks), and some money in safer, less volatile investments (Bonds, Cash, etc.)

In my experience, the majority of investors fit this bill…especially if they are at or nearing retirement.  For these investors, the key is understanding the tax ramifications of the different kinds of accounts.  If I want to take $1 out of a Roth account, I take the dollar out and spend it, end of story.  If I want to spend $1 out of an IRA, I give the government their portion (ex. 30%), and I get 70 cents.  One dollar in an IRA is NOT worth the same as one dollar in a Roth.

So why is this concept important?  It’s because every $1 of growth in a Roth is worth MORE than every $1 of growth in an IRA.  Therefore, if I have money invested in both Roth and IRA accounts, if I invest the growth-oriented assets in the Roth account and less growth-oriented ones in the IRA, I’m only allowing the government to take their cut on the low-growth assets, where as I’m keeping every penny of the high-growth assets.

Looking at example is always simpler, so let’s say I have $100K in a Roth and $100K in an IRA, and I’m a 50/50 investor (50% stocks, 50% cash & bonds).  For simplicity of math, let’s assume the stocks grow at 7%/year for 20 years, which results in $100K growing to $400K.  Let’s also assume that I kept the other $100K in cash, so it is still worth $100K after 20 years.  Altogether my $200K grew to $500K.

Many investors would have just maintained a uniform allocation between their IRA and Roth Accounts, resulting in each one starting with $100K and growing to $250K.  The Roth’s after-tax value would remain at $250K, but the IRA (using a 30% tax rate) would have an after-tax value of $175K, producing a net after-tax value of $425K.

Now let’s look if had kept that exact same mix of 50/50, but instead of keeping it uniform among the 2 accounts, I invested the entire $100K in the Roth in stocks and the entire $100K in the IRA in cash.  At the end of the 20 years, I have the same $500K, but with one important difference.  Because I invested the stock portion in the Roth, that account has grown to $400K, while the IRA remained at $100K.  The kicker is that the Roth is not taxed, and therefore my after-tax value of this $500K is…$500K.  Compared to my basic strategy where asset location was not considered, this exact same investment netted me and additional $75,000 over 20 years.  Who says there is no free lunch in investing?

Obviously this was just a hypothetical scenario, so how his this played out in real life?  I looked at every at 20-year period since 1930 and plotted the results below, using the assumptions above of an equal weighting of stock/bond and IRA/Roth and a 30% tax rate, and starting with $100,000.

In every 20-year period, optimizing the asset location by putting stocks in the Roth and bonds in the IRA resulted in a greater after-tax value than having the same mix blended between the two accounts.  On average, the optimized portfolio yielded an extra almost $50,000 in value, which works out to be about an 8% premium.

In general, investing is hard and comes with a lot of unknowns.  We do everything we can to eliminate as many unknowns as possible and squeeze out as much risk-adjusted return as we can.  This is one strategy that isn’t difficult to implement, bears no additional risk, and has no additional cost, yet it can provide a substantial long-term premium for many investors. Opportunities that meet this criteria are few and far between, and should absolutely be taken advantage of by all investors.

Planning and advisory services provided through Keystone Wealth Partners, LLC , a  federally registered investment adviser under the Investment Advisers Act of 1940. Registration does not imply Information a certain level of skill or training.  More information about Keystone can be found by visiting www.adviserinfo.sec.gov and searching by the adviser’s name. This is prepared for informational purposes only and may not be applicable to your particular situation or need(s). It does not address specific investment objectives.  Information in these materials are from sources Keystone Wealth Partners, LLC deems reliable, however we do not attest to their accuracy.  Past performance is not indicative of future results.

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