Optimal Portfolio Choice
In order to maximize performance of a financial portfolio, it is often advised that an investor place income-generating investments (e.g., bonds) into tax-deferred or non-taxable accounts and place equity investments (e.g., index funds) into taxable accounts. This is to fully utilize any long-term capital gain, or capital gains allowances available, to provide the optimal after-tax return on investment.
Actively managed mutual funds or unit trusts may also prove to be better located in tax-sheltered vehicles, because equities held through financial intermediaries tend to be taxed more, due to high turnover, than individual equities held by an investor for the long term, who has the opportunity to plan the realization of gains and offset losses. Siegel and Montgomery demonstrate conclusively that taxes and inflation substantially dampen compound returns especially for equity investors.
Tax-exempt bonds, national savings certificates and other similar tax-privileged securities are best located in fully taxable accounts. Shoven and Sialm provided an analysis of the decision point when income producing equities should be sheltered and optimal portfolio choice for each type of account. Individual stocks, passive index funds, or exchange-traded funds are generally regarded as tax-efficient and, consequently, better placed in taxable accounts, when more heavily taxed income generating assets, such as bonds, real estate investment trusts, and so on, are available for secretion in a tax sheltered location.
Read more about this topic: Asset Location
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