Asset Location Strategy: How to Maximize Your After-Tax Investment Returns

Most people have heard of asset allocation—dividing your money among different types of investments like stocks, bonds, and real estate. But many have not heard of asset location, which is just as important. Asset location means putting the right kinds of investments in the right types of accounts to lower your tax bill. It helps you keep more of the money your investments earn, especially if you’re saving for retirement or already retired.

Understanding the Tax Triangle

To understand asset location, you need to understand the three kinds of accounts in the “tax triangle”: taxable, tax-deferred, and tax-free.

Taxable Accounts

These are accounts like brokerage or investment accounts that you pay taxes on each year. Any dividends, interest, or capital gains are taxed in the year they are earned. While you have flexibility and access to your money at any time, the trade-off is more frequent taxation.

Tax-Deferred Accounts

These include 401(k)s and traditional IRAs. You don’t pay taxes when you put money in or while it grows, but you pay income tax when you take money out in retirement. This helps you grow your money faster in the short term but leads to larger tax bills later unless managed wisely.

Tax-Free Accounts

Examples include Roth IRAs and Roth 401(k)s. You pay taxes upfront when you contribute, but your money grows tax-free, and you can withdraw it tax-free in retirement. These accounts are powerful tools in a long-term tax strategy.

What Belongs Where? Matching Assets to Accounts

Certain investments are more tax-efficient than others. Placing them in the right type of account can make a huge difference over time.

Where to Hold Bonds

Bonds often create interest income that’s taxed at your regular income tax rate. Because of this, bonds are usually best held in tax-deferred accounts like traditional IRAs. That way, you delay taxes until retirement, when your income might be lower.

Where to Hold Stocks

Stocks are more tax-efficient because they often grow in value without needing to be sold right away. Many also pay qualified dividends, which are taxed at a lower rate. For these reasons, stocks are often best placed in taxable accounts, where they can take advantage of lower capital gains taxes and tax-loss harvesting strategies.

REITs and Real Estate Funds

Real Estate Investment Trusts (REITs) usually pay out high income that is taxed like regular income. This makes them a good choice for tax-deferred accounts, where you avoid taxes each year and only pay when you withdraw.

Municipal Bonds

These are a special case. The interest paid by municipal bonds is often exempt from federal (and sometimes state) income taxes. Because of their built-in tax clarity, they are best kept in taxable accounts rather than tax-advantaged accounts where the benefit would be wasted.

Using Roth Conversions to Improve Location

A Roth conversion is when you move money from a traditional IRA into a Roth IRA and pay taxes now so you don’t have to later. This can be smart if you expect your tax rate to rise in the future or if you’re having a low-income year. Moving high-growth assets like small-cap stocks into a Roth IRA can be especially powerful because all future growth will be completely tax-free. The timing of Roth conversions matters. Doing them early in retirement or in low-tax years helps manage your total lifetime tax bill.

Advanced Strategy: Thematic and ESG Investing

Some people invest in ESG (Environmental, Social, Governance) or thematic funds. These funds often have high turnover and unique holdings that can trigger taxes if not placed wisely. If you’re passionate about making an impact and investing in these types of funds, it’s usually best to keep them in tax-advantaged accounts like IRAs or Roths to avoid the tax drag from frequent trading or distributions.

Target-Date Funds: Not Always Ideal

Target-date funds are popular in 401(k)s and IRAs because they adjust your asset mix as you near retirement. But if you own them in multiple account types, they can ruin your asset location strategy. For example, holding the same target-date fund in both a Roth IRA and a taxable account often leads to inefficient tax placement. Instead, build a custom portfolio in each account to match your goals and tax situation.

Common Mistakes High Earners Make

People with high incomes often make simple asset location mistakes. For example, they may keep dividend-heavy mutual funds in taxable accounts instead of tax-deferred ones. Or, they may ignore the power of Roth accounts entirely, choosing short-term tax breaks over long-term growth. High earners should also be careful when selling investments from taxable accounts, as large capital gains can push them into a higher tax bracket or make them subject to higher Medicare premiums. Coordinating where you hold each investment helps reduce taxes now and in the future.

How to Measure Your Portfolio’s Tax Efficiency

You can “grade” your asset location by calculating the tax-efficiency of each investment and where it’s located. Some financial software and advisors offer a “tax-efficiency score,” which looks at how much tax you pay each year from your investments. A more tax-efficient portfolio will let you keep more of your gains and grow your net worth faster. Reviewing this score annually helps make adjustments as tax laws or your personal income changes.

Final Thoughts: Putting It All Together

Asset location is a powerful but often overlooked part of smart investing. By putting the right investments into the right kinds of accounts—taxable, tax-deferred, or tax-free—you can earn more over time without taking extra risk. Whether your portfolio is large or small, understanding asset location helps you keep more of what you earn and reach your goals faster. As you plan your investments, don’t just ask “what should I buy?” Ask, “where should I hold it?”