How Asset Location Helps Advisors Grow Their Business

Do the math: Multiply the investment options for investors today by the types of accounts they can hold, and you can quickly see why advisors need to help clients understand the concept of asset location.

Asset location is the practice advisors use to help clients choose the right types of investments to hold in the accounts that yield the best tax benefits (or, as we call it, tax efficiency).

LifeYield technology helps advisors measure and score the tax efficiency of client and household portfolios and then recommend asset locations that make those portfolios more tax efficient.

Not to be confused with asset allocation (more on that later), asset location promises that investors can:

• Save more of their investment gains for retirement, and
• Pay what they legally owe in taxes – but no more.

It’s easy to see why asset location is a concept that forward-thinking advisors put into practice when helping clients manage investments to produce the desired returns and the retirement income they’ll need.

What Is Asset Location?

Let’s start with what it’s not. It’s common to confuse the similar-sounding asset allocation with asset location. As an advisor, you’re the one who explains the difference between the two and the different accounts that a client’s investments can be distributed among.

Asset allocation is where it all begins. It is a strategy that works to balance the risk versus the rewards of investing by adjusting the percentage of assets within the portfolio based on client risk tolerance, financial goals, and investment period (how long the client intends to hold the investments).

Asset location is a tax-minimizing strategy that allocates a portfolio’s investments among accounts with different tax treatments. The types of taxable accounts include taxable, tax-deferred, and tax-exempt (together, called tax-advantaged).

Asset allocation and asset location together help advisors:

• Manage the bigger picture: Before you can organize client assets across accounts with different tax treatments, you must do the work that goes into a client’s or household’s asset allocation. That includes thoughtfully learning about clients’ investment goals and risk tolerances.
• Establish the goals and the timeframe: What are the client’s intentions for the accounts in which they hold investments? New home? Funding private or college education? Retirement income? Understanding goals and timelines leads to the next step of uncovering the investment opportunities for portfolios and which types of accounts they belong in.
• Manage taxable and tax-advantaged accounts: Tax codes evolve and change – significantly, in recent memory. Advisors need to rely on more than keeping up with the news. Software that reflects tax law changes and timelines is the advisor’s right hand.

How Financial Advisors Put Asset Location to Work for Clients

In go-go markets, clients tend to want to be sure they’re not missing out on returns those stocks are throwing off. In bear markets, clients tend to seek safer places for their money. It’s human nature.

Economic cycles, however, aren’t the only things that go up and down. Taxes do too, as experience proves. That means that financial advisors must tailor recommendations to meet client goals, timeline, risk tolerance – and their tax exposure.

So, financial advisors need to look hard at clients’ taxable income, filing status, state of residence, and investment gains and losses, among other factors. And they need to evaluate what types of investments clients are holding in taxable accounts (usually brokerage accounts); tax-deferred accounts, like 401(k) plans and individual retirement accounts (IRAs), and tax-exempt accounts, such as Roth IRAs or Roth 401(k)s.

Seeing Asset Location In Action

Let’s look at hypothetical investor Sally, a self-employed accountant. She has a brokerage account and is investing in individual stocks, mutual funds, and exchange-traded funds. Sally watches the markets and financial news. She considers herself a wise investor.

When you meet with Sally for the first time, however, you find out that she hasn’t started an account that will allow her to save for retirement – either through tax-deferral, like a SIMPLE IRA or through tax exemption, like a Roth IRA.

Sally may be enjoying managing her investments, but she’s losing the tax advantages of investing through a tax-advantaged account available to someone who is self-employed. Sally could be saving on current income taxes with a tax-deferred account or on future income taxes with a tax-exempt account.

Now take Bob, a 33-year-old business analyst. Like Sally, he’s been in the markets for a few years by investing through a brokerage account. Bob, however,  has enrolled in his new employer’s 401(k) plan, but he isn’t maxing out his contributions (and so leaving some employer matching dollars on the table).

When you examine his portfolio, you also find that he’s invested in his 401(k) in bond and balanced funds that are less volatile but also may not provide Bob with the growth he’s looking for in retirement.

You do an analysis of Bob’s asset location and show him how he’s paying taxes today on his brokerage account and not taking full advantage of the tax-deferral opportunity of his 401(k) account – or the potential for growth between today and the 30 or more years until he retires.

Make Asset Location Analysis Part of your Practice

In the past, another hypothetical client, Ruth, who is in her 50s sought an advisor’s services for sorting out of the various accounts – taxable and tax-advantaged – she’s accumulated over 30 years of working, saving, and investing. Ruth is, frankly, worried about having enough money to retire in 15 years.

That advisor would have generated a proposal for changes in the investments held in the accounts that could potentially accelerate accumulation, explained the rationale to Ruth, and sought her agreement to move forward.

What was missing? Considering Ruth’s tax liabilities – today and in the future.  What’s more, Ruth is married, and her spouse has a similar checkerboard of investments. For them, retirement isn’t a one-person show. Nor are taxes.

Enter asset location analysis. With LifeYield Asset Location, advisors can analyze the tax efficiency of all the accounts in the household’s portfolio and assign a score on a scale of 0 to 100, with 100 representing the best possible tax efficiency of the household’s portfolios.

With that score in hand, the advisor uses the software to optimize tax efficiency, producing recommendations for how to improve the tax efficiency of the accounts held by both Ruth and her spouse.

And, it’s more than a score: LifeYield Asset Location estimates the potential tax savings (*equals* money Ruth and spouse will have to spend as they choose) over their time horizon for retirement.

Make the Case for Asset Location to Clients

Experts agree that taxes are among the – if not the – highest cost investors have in retirement, running neck and neck with health care and housing. Focusing retirement planning only on accumulation and not factoring in tax efficiency will let clients down.

LifeYield works with the largest firms in financial services. Its technology, available as APIs, or application software interfaces, plugs into those firms’ tech stacks to make them richer in capability and productivity. Other LifeYield solutions work in harmony with Asset Location, including LifeYield:

• Multi-Account Rebalancing – incorporates multi-account tax harvesting and automated asset location optimization into a firm’s rebalancing software.
• Tax-Smart Withdrawals – shows how to execute the most tax-optimized withdrawals from multiple accounts by selling mislocated assets, minimizing drift, and identifying opportunities to harvest losses.
• Tax Harvesting – scans all taxable and non-taxable accounts, instantly identifying opportunities to harvest gains or losses, depending on the need of the client household.
• Social Security+ – identify the optimal filing strategy for each investment client and use Income Layers to visually demonstrate different scenarios to transition to retirement income.

An independent analysis by EY found that tax-smart asset location and multi-source income withdrawals can improve after-tax returns and income by up to 33 percent over an investor’s lifetime. That is a number that will capture clients’ attention. It also sets your expertise apart from that of advisors clients worked with in the past.