Asset Allocation vs Asset Location: Don't Confuse Them

Asset location and asset allocation are two terms that seem to be very similar without taking a detailed look at both. While they are similar, you do not want to confuse the two because they represent two completely different concepts. Here are the basics of asset location and asset allocation and how they differ.

Asset Allocation

Asset allocation is a strategy that is used in order to lower the overall risk of a portfolio. Within an investment portfolio, an investor should have several different classes of investments. For example, they might decide to put part of their money into the stock market, another part into the bond market, and another part into cash or cash equivalents. All three of these different categories of investments have some benefits for investors. When you combine them, you are going to try to maximize the profit potential while lowering the risk at the same time. By putting some of your money in stocks, you are going to be able to take advantage of growth in the market. By leaving some of your money in bonds, you are going to get consistent interest payments and steady growth for your portfolio. By leaving some money in cash, you are going to provide some safety to your portfolio.

The asset allocation should change depending on your unique situation as an investor. For example, when you are younger, you should put more of your money into stocks. You have a longer time horizon and there is more time to make up for mistakes. If you choose the right stocks, it could potentially provide you with a lot of gain. When you get older, you will want to transition most of your funds into safer investments like mutual funds and bonds.

Asset Location

Asset location is another concept that deals with where specific assets are located in your portfolio. However, with this strategy, you are looking to maximize your tax advantages. You are going to use both a traditional investment account and a tax-advantaged retirement account such as a 401(k) or an IRA. Certain investments are taxed at different rates. With asset location, you are going to try to maximize your profit by putting the right investments in the right account. For example, dividends and long-term capital gains are taxed at a rate of 15 percent. Interest income from bonds is taxed at your marginal tax rate. This could be as high as 35 percent and there is a good chance that it is going to be higher than 15 percent. Therefore, if you had money in stocks and bonds, you would want to put the bonds in a retirement account so that you will not have to pay taxes on the interest income. Instead, you are going to be paying taxes on the lower tax rate of the dividends and long-term capital gains from your stock investments. By analyzing tax consequences, you can maximize your profit over the long-term.

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