A comment in my last post reminded me that one of the best ways to maximize your investment return is to avoid as much tax (legally) as possible. One way to do this is to divide your mutual funds or other investments in the most ideal place in your taxable and tax-deferred (401k, IRA, 403b, etc.) accounts. Of course, you want to keep as much of everything in tax-deferred accounts as possible, but often that is not possible. So what investments are the most tax-friendly? Below is a list compiled by Taylor Larimore on the Diehards.org forums, and it agrees pretty much with what I’ve read in books such as the Four Pillars of Investing:
Hi-Yield Bonds (least tax-efficient)
Taxable Bonds
TIPS
REIT Stocks
Stock trading accounts
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth Stocks
Most stock index funds
Tax-Managed Funds
EE and I-Bonds
Tax-Exempt Bonds (most tax efficient)
So overall I should be looking at putting my bonds in my Roth IRA and 401ks, and keeping the stocks in my taxable accounts. However, for now, almost all of my long-term money is already in tax-deferred accounts, so I’m not going to bother yet. Soon though!
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I’ve seen that advice before at Diehards.org and always wonder whether or not I should be second guessing it. My main “beef” with putting bonds in my Roth is that I really don’t think that is great advice for the young investor. I don’t have raw numbers to back this up –> but I’ve always thought that, as an investor starting out, I should be fairly aggressive with my Roth. Why put bonds in a Roth, at age 25, when you could be loading it with micro-caps, emerging markets..etc. I’m not saying that this should be the only asset classes in your Roth…but it just seems that if you put 10% away in bonds, your losing some amount of return (over the long haul) which would would be adding to the aggregate amount you have at retirement coming out TAX FREE. I can see the validity of the advice for a time when my portfolio becomes more conservative 5-10 years before retirement…but I just don’t see how putting bonds in my Roth, at a young age, is all that great of an idea. I think I’ll be sticking to having them in my 401(k) for the foreseeable future.
Interesting point. I think we agree that overall, one should try to keep bonds in any tax-sheltered place to avoid taxes on the coupons at our marginal tax rate.
Actually I think you are right in that you should put your most tax-inefficent assets in a 401(k)s and Trad IRAs (bonds). THEN I should put the next most inefficient stuff into an Roth IRA. I mixed that up. Thanks for clearing that up for me.