Tax-Efficient Investing: Why Where You Hold Your Investments Matters

Choosing investments is only one part of building a long-term portfolio. Another important consideration is how those investments are positioned from a tax perspective.

Tax-efficient investing is the practice of organizing investments in a way that seeks to reduce unnecessary taxes over time. While taxes cannot be eliminated, thoughtful planning may help reduce tax drag and allow more of your portfolio to remain invested.

Understanding How Investments Are Taxed

Not all investment income receives the same tax treatment.

Depending on the investment, returns may come in the form of:

• Interest income

• Dividends

• Short-term capital gains

• Long-term capital gains

  
  

Each type of income may be taxed differently under current tax law. For example, short-term capital gains are generally taxed as ordinary income, while long-term capital gains often receive more favorable federal tax treatment.

Because investments generate returns in different ways, the taxes owed can vary even when two investments produce similar overall returns.

Looking Beyond Asset Allocation

Most investors are familiar with asset allocation, deciding how much of a portfolio should be invested in stocks, bonds, cash, and other asset classes.

Asset location is a related concept that focuses on where those investments are held.

Common account types include:

• Taxable brokerage accounts

• Traditional tax-deferred retirement accounts

• Roth accounts, which may provide tax-free qualified withdrawals

  
  

While asset allocation determines what you own, asset location considers where you own it.

This distinction can influence how much of your investment return is ultimately available after taxes.

There Is No Universal Formula

The tax characteristics of an investment are just one factor to consider when deciding where it should be held.

For example, an investment that generates regular taxable income may be more tax-efficient in a tax-advantaged retirement account, while an investment that produces fewer taxable events may be well suited for a taxable account.

However, asset location is not simply a matter of placing bonds in retirement accounts and stocks in taxable accounts. Factors such as an investment's expected rate of return, turnover, embedded capital gains, an investor's current and future tax brackets, and long-term withdrawal goals can all influence the most tax-efficient approach.

Rather than applying a single rule to every portfolio, asset location is about evaluating how each investment fits within an investor's overall financial plan. The objective is to position investments in a way that may improve long-term, after-tax outcomes while remaining aligned with the investor's goals.

Why Tax Efficiency Matters Over Time

Taxes, investment expenses, and inflation can all affect long-term investment results.

While taxes cannot be eliminated entirely, thoughtful portfolio design may help manage when taxes are recognized and how frequently taxable events occur. Over many years, reducing unnecessary tax drag may allow more assets to remain invested and continue compounding.

Because every investor's financial situation is unique, tax-efficient strategies should be evaluated within the context of an individual's overall financial plan and in consultation with qualified tax and financial professionals.

John P. Freund is registered with and securities are offered through Kovack Securities, Inc. Member FINRA/SIPC. 6451 N. Federal Highway, Suite 1201, Ft. Lauderdale, FL 33308 (954) 782-4771 Investment Advisory services are offered through Kovack Advisors, Inc. Naples Financial Solutions, LLC is not associated with Kovack Securities, Inc. or Kovack Advisors, Inc.

Naples Financial Solutions does not provide legal or tax advice. The information herein is for educational and informational purpose only and is not a recommendation regarding any security or investment strategy. This should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Naples Financial Solutions cannot guarantee that the information herein is accurate, complete, or timely. Naples Financial Solutions makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money. Asset allocations and diversification cannot guarantee profit or insure against a loss. There is no guarantee that any investment strategy will be successful; all investing involves risk, including the possible loss of principal.