On this episode of Finance in a Flash Chip and John sit down to discuss, tax-efficient investing and the importance of “Asset Location.” Chip and John talk about which types of investments should be held in which accounts and why that may vary based on your stage in life.
On this episode of Finance in a Flash Chip and John sit down to discuss, tax-efficient investing and the importance of “Asset Location.” Chip and John talk about which types of investments should be held in which accounts and why that may vary based on your stage in life.
Hey there everyone, and welcome back to another episode of Finance and a Flash. I'm your host, John Mato, and today I'm joined again by Chip. Hi, Miller Chip. How are you doing today?
Speaker 2:Hey there, John. I'm great. I'm doing, I'm doing wonderful. I hope you are.
Speaker 1:Yeah, I'm doing great. It's a, it's a big day today, isn't it?
Speaker 2:It is a big day. It's, it's, it's, we're on the, the cusp of the NCAA basketball tournament. I just, it's the most exciting time of the year and, uh, today it's like the day before Christmas or birthday or something as a kid,<laugh>, and, you know, it's just, I'm, I'm, I'm right with anticipation.
Speaker 1:Yeah. March Madness begins, and I think, I don't know about you, but I've picked my teams, I've submitted my bracket to this year's bracket challenge, the official bracket challenge of Beacon, and, um, I'm feeling pretty good. Are you, are you still as confident as you were last week? I looked through a lot of data, did a lot of research. Um, I'm, I'm
Speaker 2:Feeling good. All right. You're, you're, you're bringing it then. I like it. I, I'm feeling pretty good too. I, I sat down this week and, um, made my choices and, um, ho hopefully the teams I select are, are really gonna pull it off. I, I, I had a couple of big upsets, but, um, you know, as that happens every year, so it's gonna be a great, a great time and I'm, I'm really looking forward to bringing home the trophy<laugh>
Speaker 1:<laugh>. Well, I'm, I'm, I personally am hopeful you don't bring it home. I'm hoping that I do. Um, and I think I've heard from some of our listeners that they're hopeful I win too, so, um, just Oh,
Speaker 2:Okay. Out there. Well, good. All right. I'm, I'm, I'm kind of, uh, the dark horse that maybe, I don't know.
Speaker 1:Yeah. Um, you know, and it's funny you mentioned picking the, picking the upsets. I think that's almost more fun than anything else. If you get one of those upsets right in the beginning, especially with one of those lower seeds beaten like a high seed. It's just feel, it's, it's, it's like, it's, it's, it's awesome cuz you're like, oh my gosh, I can't believe I picked, and then, you know, they, you hear'em talking on E S P N and they're saying like, oh, 3% of brackets had this one. And you're thinking, oh, that was me. That was
Speaker 2:Me.<laugh>. That's right. Yeah. Ha. Has there, has anyone ever gotten a perfect bracket? I, I don't know that they have, although in the age of, you know, computer generation, maybe someone can just generate hundreds of brackets and one of'em is, is correct. I don't know. I, I, it seems out of the, out out of the realm of possibility or something, but I'm intrigued by that. So may maybe this will be the first for us. We'll, we'll have, we'll have one in-house, a perfect, a perfect
Speaker 1:<laugh>. Now that would be, that'd be pretty cool next year. I'm sure they would feature on e s, ESPN and they'd be out there telling how, how they made their selections and all that.
Speaker 2:<laugh>, uh, maybe I need to buy a new suit for that. I don't know.<laugh><laugh>,
Speaker 1:Well, they, they do have some great suits there on ESPN n but, um, well, chip, today we have, have another exciting topic to discuss, um, tax efficient investing and the importance of asset location, like most topics we discussed here on finance and a flash. We get a lot of questions around this topic. So I, I think to start off, it's important to understand the tax implications of various accounts. There's tons of different account types out there, but here at Beacon, a lot of our clients either have a personal or have a personal brokerage account or a joint account for, um, couples. Um, they have an IRA and a Roth, I rra. So Chip, could you kind of discuss the tax implications that come into play, um, specifically around those accounts?
Speaker 2:Yeah, and I'll just say that, you know, having an investment strategy that is, uh, tax efficient is so super important. It adds a tremendous amount of value over time. And it, it's a, it's, uh, one of those things that, you know, we've, I we, I've been doing this long enough to see the benefits of that, and it really just increases the probability of successful outcomes for clients. And, um, and that's really what we try to focus on there. But, you know, when you ask the question about, uh, different types of accounts that that's, that's really the key. So think about, you know, for us it's a personal brokerage account, um, an IRA or a 401k, and then a Roth, I r a, each of those different types of accounts have extremely different ways that they're taxed. And so as you, as you might know, you know, a personal brokerage account, any income that an investment generates throughout the course of the year, you know, if it's interest income or if it's, you know, realized gains or if it's, you know, dividend income, those sources of income are taxed within a personal brokerage account and investors receive a 10 99 each year, um, with an IRA or a four oh[inaudible] plan, you know, any income that the investments generate, you know, it's deferred. You're not taxed on that each and every year. It's, it's just, it kind of accumulates in the account and, and it's just deferred. And, and same goes with the Roth. It's any income that the investments generate or, uh, any realized capital gains, it's, it's just, uh, an tax exempt account. Roth IRAs are probably the best, uh, from that standpoint. But, you know, that's kind of what we're talking about. Which types of investments should we position in each type of account.
Speaker 1:Yeah, thanks Chip. And I, I, I think that's, when understanding this topic as a whole, I think it's really under important to understand, um, the various pieces that go into it. So kind of with all you just said, how could the average investor kind of take those things, um, and and use'em to their advantage?
Speaker 2:Oh, yeah. So think, think about this. I mean, if you have an investment, uh, well, let's say that a person decides that, okay, they need 50% stocks and 50% bonds, that's their, what their risk profile says. That's what their, how, what type of portfolio they feel comfortable with. Well, if you think about it, you know, which types of investments should be in each account, right? So if you have a, an income investment, a bond fund for example, you know, which account is it better to be in if it's in a personal brokerage account, in any of that interest that's generated from the bond is taxed to you each and every year. And so we wanna make sure that, you know, we, we position the tax inefficient investments, and that could be bond funds, it could be REITs, uh, real estate investments, it could be high yield bonds, it could be, you know, uh, inefficient mutual funds, uh, you know, tax, uh, that have high turnover and that sort of thing could be a number of different things we want. We want those investments to be in accounts that are tax deferred. You know, we don't like the fact that, you know, uh, we don't like filling out that, uh, you know, ten nine, we don't want like to get the 10 99 each year. We don't want to have to pay taxes on it. And so, you know, in contrast, you have other investments that are really tax efficient, right? So what, what are they? Well, they could be, you know, municipal bonds, they're pretty tax efficient. They generate income, they're, you get a federal and some cases state tax, uh, benefit from owning those, you know, also index funds. Index funds are generally pretty tax efficient. Um, you know, unless the index changes significantly, they're, they're really tax efficient. There's not a lot of capital gain distributions or, uh, income that's generated, uh, oftentimes from especially stock index funds. So, you know, for those types of investments, we might put those in a personal brokerage account, your tax sufficient, uh, index funds and maybe some municipal bonds, you know, so, you know, whereas within your I R A, maybe that's where you wanna put your REITs and your high yield bond funds and your, the vast majority of your bond allocation, you know, and so we just wanna be aware of that and, and also be aware of the client specific circumstances and that that really dictates the investment strategy that we use.
Speaker 1:Jim, I, I think you, you think you hit on something there That is a great segue into our next question is, is kind of the client specific situation. So, so what are some guidelines you would ha have or maybe suggest for making asset location decisions for those who are, who are in or maybe approaching retirement?
Speaker 2:Yeah, so I mean, again, if you're, if you're approaching retirement, you're probably, you know, at the latter stages of the accumulation phase. So you might be in the highest, you know, your highest earning years. And so with that being said, we wanna make sure that, you know, uh, we want to, uh, you know, reduce the amount of investment income that a person has. And we do that by putting certain investments in, uh, tax deferred deferred accounts. And, and that really is the biggest strategy there. The other thing, uh, to keep in mind, and we really haven't hit on this, um, a lot yet, but, you know, IRAs especially ha ha are, you know, when you're, when you're approaching retirement, you're thinking about, okay, where are my cash flows in retirement going to come from? Well, you know, if it's, if the IRA is a source of that income, then you have to think about, well, if I pull money out of an ira, that's gonna be tax dollar for dollar. Whereas, you know, in a personal brokerage account, for example, you're only really taxed on any capital gains that you realize. And so, uh, and those two tax rates are different, uh, which is also adds an element of complexity to it, right? So, and you have to think about, okay, where is a person, uh, at right now in their lives? Like which tax brackets are they in now? Which, what tax bracket versus where they might be in subsequent years, like if they're retired, you know, maybe their income level dropped significantly. And so, you know, maybe you have, uh, you want to, uh, alter your investment strategy slightly to, to accommodate that period of time in which the person is, uh, currently living in and what their income rates are and that sort of thing.
Speaker 1:Yeah. And, and kind of all the factors, um, we've kind of been discussing so far, you know, play a role in deciding the asset location for, um, you know, specific clients. And there, there're really no hard and fast rules, but I'll, I'll tell you this, um, here, you know, behind the scenes, we, we take a lot of, uh, a lot of measures, you know, with the clients, you know, with our clients to create an asset location strategy that works best given in every client's personal circumstances and preference. You know, chip, it sounds like to me that portfolio customization in this case is really, is really crucial.
Speaker 2:It really is. And it's, and it's customization to a, a, a, a whole different level if you really think about it, because it, it evolves over time. And, you know, I'm not saying that you need to go in and restructure your entire portfolio every year, but it's just simply being aware of where you expect a client to be from a tax standpoint during certain phases of their lives. And, and that's kind of what, you know, we bring to the table and, and providing guidance there and really making suggestions that, again, can increase the probability of successful outcomes. That's really what we're trying to do with our client base. And, uh, and really this is a very, you know, optimizing a portfolio from a tax standpoint is so beneficial to clients, uh, especially as you compound tho that over periods of time. And that's really what we, uh, we think we can add a lot of value to clients, uh, in this situation for sure.
Speaker 1:Yeah, I would, I totally agree with that Chip. And, um, we've highlighted the power of compounding and, and other podcasts and, and I know me and you talk about it a lot off air, but Chip, um, do you have any parting thoughts today before we wrap this up?
Speaker 2:Yeah, I mean, I'll just say that, uh, this, you know, tax asset location is super important, uh, but it also kind of piggybacks on distribution strategies. You know, if you think about, um, retirees, you know, which accounts, uh, are they gonna, where, what's gonna be the source of their cash flow in retirement? And, you know, we wanna, we wanna make sure that we are giving advice and the best advice on the distribution strategy as well, and also things that come into play too, is, you know, things like, okay, what happens when, uh, an IRA owner passes away, an account owner passes away, you know, what happens for their children and how they inherit that money and how, what types of investments are best given that situation? Uh, also with a Roth I ira, if you think about that, you know, you know, we wanna leverage the fact that a Roth IRA is tax exempt, it's never taxed. And so, you know, we're not, we're probably not gonna put for most clients, you know, a lot of very conservative, very, um, you know, uh, low risk types of investments, you know, short-term bond funds may not be in a Roth ira because really what we wanna do is over the course of a investment cycle, we want to take advantage of the fact that, you know, stocks move forward, move up, there's growth there, and we wanna leverage that tax exempt status of Roth. So if we think about a 50 50 allocation for clients, you know, maybe a Roth I r is a relatively, for most people, relatively small account for them, uh, percentage wise, you know, maybe it's 20% of their overall portfolio. Well, heck, maybe we wanna put the vast majority of Roth, we wanna put, uh, growth investments in there. And so, you know, we wanna leverage and take advantage of all of those decisions along the way in order to, to do what's best for the client and also their, their their family. And so that's, that's, uh, the parting thoughts that I had there, and I, I think it's a, a super fascinating, um, discussion to have. And, uh, but it's one that's, it's super important and it's beneficial to clients if you can, uh, structure portfolio that to minimize taxes.
Speaker 1:Yeah, it's super important and, and super interesting. I know it's something that we go through kind of at the beginning, right? As right as you know, clients are getting onboarded and then reinforce as we meet almost every single time.
Speaker 2:We sure do. And because it's one of those things that requires, you know, you, you repeat, you repeat this because it's, it's, you know, if you're not a practitioner and kind of involved in the industry, it's easy to forget, you know, heck, why, why is one account performing differently than the other? Oh, well, the, the Roth I R A A is gonna perform differently because we've, we've positioned more equity exposure in that account. And the reason we do that is because, you know, we wanna leverage the, the tax exempt nature of a Roth I R a. That's why we do that all. Why there, you know, why do we have more bonds in our, in our I R A and 401k? Well, the reason for that is because they're income generators and they're tax inefficient. They're, we're, we're positioning a lot of the tax inefficient investments in, uh, IRAs, 401ks. And then the question might be, well, gosh, you know, why, why do we have, you know, uh, you know, index funds in a personal brokerage account? Well, that's because they're very tax efficient. They're not generating lots of income. Uh, we're, we're really focusing on, uh, you know, gains and growth and, and that, and it's tax efficient growth. And so, you know, we just, you think about those things and when you structure your portfolio to maximize the benefit of certain types of investments, then, then you really are, uh, leveraging, you know, information to your advantage and, and, and the outcomes are just, uh, so much, so much better.
Speaker 1:Yeah, I totally agree with all that. Well, chip, this is, this has been a fun one and an important topic that we've discussed today. I want to give you a big thank you for joining us today, and I also want to give a big thank you and shout out to our listeners. We appreciate you listening to us, and we'll see you the next time.