Two Different Investment Strategies
When hearing the terms asset allocation and asset location, many of us conclude that these are synonyms. These terms are actually two separate investment strategies that can be used in tandem to create a well-balanced portfolio capable of reducing risk and minimizing tax.
Asset allocation is the more commonly known term and is the strategy of diversifying a portfolio across different asset categories to reduce overall portfolio risk. There are many investment categories and sub-categories, with the most common categories being stocks and bonds. Which investment categories to use and how much of the total portfolio to put into each investment category is a decision that is dependent on the investor’s situation and risk preferences. Finding the proper asset allocation that will match an investor’s tolerance for volatility is a crucial decision that will help maximize risk-adjusted investment returns.
Asset location is the investment strategy of holding different asset categories across distinct types of investment accounts. For most investors, there are two types of investment accounts to utilize: taxable accounts and retirement accounts. Within retirement accounts, there is a further distinction between traditional and Roth accounts. Each of these account types receive different tax treatments. Asset categories also receive different forms of tax treatment, from ordinary tax rates, to preferred or reduced tax rates, to even being tax-free. Matching up investment categories to an appropriate investment account is a major decision in reducing or eliminating the burden of tax on investment income.
The financial planning adage that all investor situations and decisions are different and dependent on the investor’s personal circumstances holds very true for the investment strategies of asset location and asset allocation. Two investors could have asset locations that are contrary to each other, but both could still have the appropriate asset location strategy for their situation.
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