The Investment Strategy That’s Better Than Stock Picking

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The biggest tax savings often hide in plain sight. 

Last year, I watched a surgeon’s eyes widen when I showed her how moving investments between accounts – without changing a single holding – could save her $12,000 in annual taxes. 

The secret? 

Understanding not just what you own, but where you own it.

Most investors focus on picking the right investments, but the real power lies in two key decisions: asset allocation and asset location. 

Let’s break down why these matter and how they can work together to help you keep more of what you earn.

Understanding Asset Allocation: Beyond the Basics

Asset allocation might sound like financial jargon, but it’s simply how you divide your investment pie. While many focus on finding the “best” investments, research tells us something surprising: your overall mix of investments matters far more than which specific ones you choose.

This isn’t just theory. 

A landmark study in 1986 found that asset allocation explained about 94% of portfolio returns. 

While this study has been debated over the years, one thing remains clear: how you divide your investments among different types of assets drives the majority of your results.

But here’s what many investors miss: asset allocation isn’t just about maximizing returns.

It’s about finding the right balance that lets you sleep at night while still reaching your goals. The “perfect” portfolio on paper means nothing if market volatility causes you to make emotional decisions that hurt your long-term results.

Making Allocation Work for You

Your ideal asset allocation depends on three key factors:

  • Your goals (what are you trying to achieve?)
  • Your timeline (when will you need the money?)
  • Your risk tolerance (how well do you handle market swings?)

Common Allocation Mistakes to Avoid

One of the biggest mistakes I see is following outdated rules of thumb. You might have heard you should subtract your age from 100 (or 110 or 120) to determine your stock allocation. While this isn’t a terrible starting point, it misses crucial factors like:

  • Your other income sources
  • Legacy goals
  • Healthcare needs
  • Business ownership
  • Pension plans

Having additional income sources or strong saving habits might mean you can take more investment risk than traditional guidelines suggest, potentially growing your wealth significantly more over time.

Asset Location: The Tax Efficiency Multiplier

While allocation determines what you earn, location determines what you keep. Think of asset location as strategic tax planning for your investments. Different investments create different types of tax obligations, and different accounts treat those obligations differently.

The Three Tax Buckets

To understand asset location, think of your accounts in three tax buckets:

  1. Tax-Deferred (Traditional 401(k)s and IRAs):
    • Contributions reduce your current taxes
    • Growth is tax-deferred
    • Withdrawals are taxed as ordinary income
    • Best for: Investments that generate regular taxable income
  2. Tax-Free (Roth accounts):
    • Contributions are made with after-tax dollars
    • Growth and qualified withdrawals are tax-free
    • Best for: Your highest-growth potential investments
  3. Taxable (Brokerage accounts):
    • No special tax treatment
    • Various tax rates depending on holding period and investment type
    • Best for: Tax-efficient investments and those you plan to hold long-term

Location Strategy in Action

Consider this example: Moving high-yield bonds from a brokerage account to an IRA while shifting index funds to the brokerage account can significantly increase after-tax returns – often by 20% or more – without changing your investment strategy or risk level. 

It’s not about changing what you own, but optimizing where you own it.

Making It All Work Together

The real power comes from combining allocation and location strategies. Here’s a framework to consider:

  1. Start with your target allocation based on your goals and risk tolerance
  2. List all your available account types and their tax treatment
  3. Match investments to their optimal accounts:
    • High-growth stocks in Roth accounts
    • Income-producing investments in tax-deferred accounts
    • Tax-efficient investments in brokerage accounts
  4. Implement changes gradually to manage tax implications
  5. Review and rebalance regularly

Small changes in how you structure your portfolio can lead to significant differences in the wealth you actually keep. 

By being strategic about both what you own and where you own it, you can potentially save thousands in taxes each year without compromising your investment strategy.

Moving Forward

Your portfolio might be working harder than it needs to. Ask yourself:

  • Does your asset allocation align with your actual goals, not just generic rules?
  • Are your investments in the most tax-efficient accounts for their type?
  • When was the last time you reviewed your location strategy?

Remember, it’s not just what you own that matters – it’s how you own it. 

These aren’t just theoretical concepts – they’re practical strategies that can help you keep more of what you earn. 

And in my experience helping professionals optimize their finances, that’s something worth paying attention to.