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Wednesday, September 15, 2010


You're probably thinking this post is about real estate. After all, this has long been the mantra in the real estate estate market - even during the housing bust.

But location is also important in investing. In fact, it is typically the most popular take away item from seminars because it immediately saves people money and is easy to implement.

Every individual's situation is a bit different, so the following shouldn't be taken as specific advice.

The first step is to get all your accounts out and sort them into non-qualified accounts and qualified accounts. Non-qualified accounts are typically your basic savings accounts. The key is that you pay taxes on any interest earned on these accounts as you earn the interest. For example, if you have a 3-year certificate-of-deposit (CD) at your local bank, you record the year's interest and pay taxes on it. If you are in the 33% tax bracket and earn $100 in interest, you get to keep $66. On the other hand, if the $100 was a qualified dividend, you would get to keep $85!

Your qualified accounts are your IRAs, 401ks, 403bs etc. These accounts are qualified under the Internal Revenue Code such that they are allowed to grow tax free. They are taxed when funds are drawn out - typically at retirement.

The strategy, then,, is very simple. To the extent possible, try to minimize the interest earned in non-qualified/basic savings accounts. Instead, seek long-term capital gains and qualified dividends in these accounts. On the other hand, use your IRAs and 401ks for your bonds, bond funds, CDs etc. , Let the interest stay in the fund and compound until it is withdrawn in retirement.

Thus, if your asset allocation is 60% stocks, 30% fixed income, 10% cash then locate your investments as follows: put cash in taxable accounts (at today's interest rates it doesn't matter!), put bonds and bond funds in your IRA/401k (and reduce this year's taxes), put stocks in both your taxable accounts(seeking long-term cap gains and qualified dividends) and qualified accounts.

As always, consult with your tax accountant and investment advisor to assess the appropriateness of investment advice for your specific case.


  1. This makes sense. I wonder about the impact of having long-term investments like stocks in tax-free accounts vs taxable accounts. Certainly in the tax-free accounts you can rebalance without worrying about cap gains eating away at your returns; even a 1% difference is significant over many years.

  2. re: Kevin you are exactly right. If you can then have all of your funds in qualified accounts. But...if you do have taxable assets pay as low taxes as you can by using equities. Rebalance in your qualified accounts. When it comes time to take a distribution sell stocks in your taxable accounts and pay 15% rather than ordinary income tax rates.
    Thanks for the comment.

  3. I only have indexes and muni bonds in taxable accounts. The rest of my bond holdings are in IRAs and 401ks. I look at all my investments holistically when it comes to asset allocation and I try to maximize tax efficiency also.

  4. I like bonds and other interest-heavy products in my RRSP and TFSA (in Canada). Defer the tax or in the latter case, tax-shelter forever! Dividend-paying stocks are unregistered, I like taking advantage of the Canadian federal gov't dividend tax credit; they give us a credit to invest and I wouldn't get that if my stocks were registered.

    Robert - anything similar to that in the U.S. - a dividend tax credit for U.S. stocks?

  5. You may also utilize your 401k and Roth IRA for investing in real estate. It is possible to use your IRA to directly invest in real estate. On the other hand, you can make transfers or loan from your 401k for real estate investing. The reason you want to do this is both retirement taxes can significantly help you to reduce taxes from this type of investment. And like what Robert said, you can have compounding interest through the years from this kind of investing method.

    For more REI articles, tips and interviews, I'm inviting you to come visit our website. :)