Patterns of Behavior
Surveys of households have shown that there is often a gulf between where assets are located and where they ought to be to provide an optimal tax outcome. Amromin argues that job income insecurity, penalties and restrictions on withdrawals from tax-deferred accounts explain why people are tax-inefficient with their investments. Employers’ matches in defined contribution retirement plans and the structure of the social security system also play a part in driving low tax equity investments into sheltered accounts.
Bodie and Crane studied TIAA-CREF participants and concluded that investors chose similar asset allocations in their taxable and tax-deferred accounts, with little apparent regard for the benefits of tax efficient asset location. Barber and Odean surveyed brokerage records and found that more than half of the households held taxable bonds in their taxable accounts, despite available alternatives, and that the preference for holding equity mutual funds in retirement accounts appeared to be stronger than that for holding taxable bonds.
Other commentators suggest decisions concerning the use of home equity and mortgage debt as a substitute for consumer debt have driven choice of portfolio location. An idealized example shows that over a 25-year interval, the difference between extreme asset location choices yielded a compounded 18% differential in return.
Read more about this topic: Asset Location
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