The Stock-Bond Shuffle of Asset Location

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Asset location is placing specific securities in specific types of accounts to maximize after-tax returns. This strategy can boost after-tax returns by as much as 1%. When we rebalance a client’s portfolio, we rebalance all of their accounts’ holdings aggregated together. This means each trade is an opportunity to optimize which holdings are in each account type.

Imagine a client who is taking monthly withdrawals from their taxable brokerage account. This account may be filled with highly appreciated stock positions and less appreciated bond positions. All other things being equal, it would be best to sell the bond positions and delay selling the appreciated stock positions.

But imagine that after months of doing this, the client’s account has gotten out of balance. They need more bonds and less stocks in their portfolio overall.

One trading technique would be to sell the bonds in the taxable account — because this avoids paying tax on the larger unrealized gains on the stock positions — and also sell stock in an IRA where there are no gains tax consequences. Then, with the cash generated in the IRA, we can buy bonds to move toward the target allocations.

Oddly, this technique might involve selling a bond position in the taxable account for a small capital gain, and buying that exact same position in an IRA in order to keep the portfolio in balance. Although this type of trading can trigger wash sales if you are selling for a loss, selling for a gain creates no such complexity.

As we do these types of odd trading techniques on a daily basis sometimes, we’ve developed nicknames for the various strategies. My favorite nickname for this strategy is “the stock-bond shuffle.” In reality, the stock-bond shuffle can be used any time you want to move a holding from one type of account to another.

Imagine a client who just completed a Roth contribution and needs to buy bonds. Buying bonds in a Roth account sometimes needs to be done, but it is better to have your more volatile securities with higher returns under the tax-free shelter of the Roth IRA. Bonds are better in a pre-tax traditional IRA, where gains are effectively taxed at income rates when they are withdrawn.

The stock-bond shuffle can then be used to sell some stocks in the IRA and buy those exact same stocks in the Roth IRA. Then, with the new money in the IRA we can purchase the bonds we wanted from the start.

This stock-bond shuffle can be confusing to clients, as it is hard to see through the weeds of the trading notifications in order to see the advantages of the larger asset location strategy. However, this fairly common trading strategy makes a small change in your annual tax bill, and it is small changes such as these which have large effects over time.

Photo by Ardian Lumi on Unsplash

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.