What is one of the most overlooked investment strategies? Asset location

When most people think about “investment strategy,” they immediately jump to asset allocation—the mix of stocks, bonds, and alternative investments that matches their risk tolerance and time horizon.

But there’s a second, equally important concept that rarely gets discussed outside of professional planning circles: Asset location.

If asset allocation is what you invest in, asset location is where you place those investments. And getting this right can add tens of thousands of dollars to your long-term wealth with zero added risk. It’s one of the purest forms of tax alpha available to physicians.

Why Asset Location Matters More for Physicians

High-income earners live in a different tax universe than the general investor. Your marginal rates are higher. Your phase-outs hit harder. Your opportunity to benefit from tax-efficient planning is significantly larger.

And most physicians end up with a variety of different investment accounts over time--whether they be a 401(k), a 401(a), a 403(b), a profit-sharing plan, a 457(b), a backdoor Roth IRA, an HSA or taxable brokerage accounts.  In fact, many have multiple versions of each of these accounts from different employers over the years if they never consolidated. More often than not, their investments are spread across accounts without a comprehensive strategy. If that is your situation, it can be overwhelming to know where to go from here.

The first step is to realize that when you are creating a portfolio, your success is not just about the growth. It’s also about tax drag and fees. I talked about how to watch out for hidden fees in a previous post here.  And about some smart withdrawal strategies here.  This post will help you reduce additional drag on your investments by strategically matching investment type with account location.  

As you accumulate, your assets end up in one of three different buckets. I can add a fourth—health savings accounts—which have their own set of rules.  Each of these buckets is taxed differently:

1. Taxable accounts → you pay annual taxes on dividends and interest income, and a capital gains tax whenever you sell your investments.

2. Tax-deferred accounts (401k/403b/457) → these are taxed at ordinary income rates when you withdraw the money after age 59 ½ (along with a 10% penalty if you withdraw before that.) You must start distributing money (RMD) from these accounts at age 73 (turns to age 75 in 2033). 

3. Roth accounts → these have tax-free growth, tax-free withdrawals, and no RMDs.

4. HSAs → the holy grail of investment accounts with a triple tax advantage: tax-deductible in, tax-free growth, tax-free out for medical spending.

   
   

The Main Idea of asset location: Match the tax efficiency of the assets with the tax advantages of the account type.

Some investments naturally produce more taxable “noise” than others:

Tax-inefficient assets

• Bond funds and bond ETFs

• Real Estate Investment Trusts (REITs)

• Actively managed mutual funds

• Target-date funds (yes, really — they have hidden turnover and generate bond income)

• Commodities/Options funds

  
  

Why are these funds tax inefficient?

• Bonds generate yearly interest income that is taxed as ordinary income. 

• REITs are required to distribute a high percentage of their yearly profits to the shareholders rather than reinvest in more deals.  Again, this income means more yearly taxes. 

• Any actively managed fund typically has high turnover of the assets in the fund due to the buying and selling of stocks or bonds by the fund manager.  Each of those trades is a taxable event (capital gains) that is passed on to the fundholders, which can result in big surprise tax bills at the end of the year. And you never even saw the money!  Not good! Targeted date funds are actively managed too, although typically with much fewer trades than a typical stock or bond fund. And they contain bonds which generate income.

• Options and commodities funds have a lot of turnover with generally short-term trades (taxed at ordinary income rates rather than capital gains rates). Commodities are non-qualified dividends (higher tax) and have some other tax rules related to futures contracts that I won’t get into.

  
  

Bottom-line:  it is best to hold tax inefficient assets in a tax-advantaged account.  That way, the income generation or asset turnover is not taxed to you each year and can keep working for you instead.

Tax-efficient assets

• Broad U.S. total market index funds

• International stock index funds

• Individual stocks (if you hold long term)

• Municipal bonds (if you need fixed income in taxable)

  
  

Why are these assets tax-efficient?

• Index funds are set up to simply match an index of stocks or bonds.  It doesn’t require much thought or insight on the part of the fund manager, so they make far fewer trades.  They only make changes if the index changes.  Fewer trades means fewer capital gains and fewer taxes.

• International stock funds are best in a taxable account because you might be able to claim a foreign tax credit from the foreign taxes on the dividends that were generated.

• Individual stocks are useful here for a couple of reasons.  One is that you have total control over the buying and the selling (unlike when you hold a mutual fund where the fund manager makes all the decisions.) If you buy and hold long term (more than a year), you are taxed at a favorable capital gains rate--which is almost always better than your ordinary income rate.  Plus, you can look for tax-loss harvesting opportunities to offset some of your gains or sell in years when your other sources of income are lower.  And you can easily donate appreciated stock to charity for another great tax deduction.  Finally, the dividends of almost all US stocks are considered “qualified dividends” and are taxed at capital gains rates, rather than ordinary income rates. 

• Municipal bonds only belong in taxable accounts.  Why? Because you don’t pay federal tax (and often state and local tax) on the income so it wouldn’t make sense to disregard this tax advantage by putting it in a 401k or IRA where you are not charged tax on the income anyway.  The whole point of owning a municipal bond is the tax break, since they generally have lower yields. 

  
  

Bottom line: your taxable accounts should hold assets that either have low turnover (index funds), tax credits (international funds, municipal bonds) or control (individual stocks).

Summing it up: The Optimal Placement Framework

Here’s the physician-friendly guide for where each asset class belongs:

1. Roth IRA / Roth 401(k): High-Growth Assets

Because Roth accounts grow tax-free, this is where you want the most long-term upside. Put your high growth stocks and funds here.

Best for:

• U.S. small-caps

• International small-caps and emerging markets: (growth and turnover outweigh foreign tax credit)

• Concentrated strategies (like sector funds or factor strategies)

• Growth-tilted funds

Anything with higher expected returns or high turnover goes here.

2. Tax-Deferred Accounts: Tax-Inefficient, Yield-Heavy Assets

Because withdrawals are taxed as ordinary income anyway, you want to shield ordinary-income-producing assets here.

Best for:

• Bonds and bond funds

• REITs

• High-yield bonds

• Balanced funds

• Target-date funds

This reduces the tax drag each year.

3. Taxable Brokerage Accounts: Tax-Efficient, Low-Turnover Assets

This is your long-term, flexible account—use it wisely.

Best for:

• Total U.S. market index funds

• Total international index funds

• Munis (if you need bonds here)

• Individual stocks with long holding periods

• Low-turnover ETFs

• Donor-advised fund (DAF) contributions from appreciated shares

These are tax efficient and benefit from long-term capital gains rates.

What is the point? Should you even worry about it?

Here's a quick example.

Two physicians each invest:

• $500k in stocks

• $500k in bonds

• Split across Roth / 401(k) / taxable

  
  

Physician A (random placement): bonds in taxable (high tax drag), stocks in 401(k) (taxed as ordinary income at withdrawal)

Physician B (smart asset location): bonds in 401(k), stocks in taxable and Roth

After 30 years, assuming normal returns and tax rates, Physician B ends up with $150,000–$300,000 more, depending on turnover, yield, and tax rates.

Same investments. Same risk. Better placement. More money.

Do I still have to worry about asset allocation?

Of course. When you are creating a smart investment portfolio, you want to always keep in mind the overall picture.  Each account has its place in your total net worth. You still need to figure out what percentage of your investment should be in stocks vs bonds, US vs international. How much cash? Any alternative investments (real estate, crypto, precious metals, etc)?  These decisions are largely based on your time horizon, your risk capacity and your risk tolerance. 

Once you create this allocation, then you layer the asset location on top.  Think of it as fine-tuning the engine once the car is built. 

Here are some Common Asset Location Mistakes

1. Holding a target-date fund in taxable

Looks simple, but very tax-inefficient due to hidden turnover and bond exposure.

2. Putting REITs in taxable

High dividends taxed at ordinary income rates = immediate drag.

3. Overstuffing Roth with bonds

Safe but wasteful. Growth belongs in the Roth.

4. Ignoring taxable accounts until late in the career

Some of your largest tax-planning opportunities happen here.

5. Forgetting to rebalance across accounts

Sometimes you'll need to use the Roth and 401(k) to make the math work.

When Asset Location Matters Most

It’s most powerful for:

• Physicians in high tax brackets

• Households with multiple account types

• Long-term investors (10+ years to retirement)

• Anyone doing Roth conversions

• Anyone who wants to build tax flexibility

  
  

Final Thoughts

Asset location is one of the easiest ways to improve long-term after-tax returns with zero additional risk.  You don’t need complex spreadsheets or exotic strategies. You just need to place the right assets in the right accounts based on how they’re taxed. Small changes can lead to big differences in the long term.

The other problem?  Everything changes after you retire.  Stay tuned for the next blog post where I talk all about that.

If you’d like help with creating a good allocation strategy as part of a comprehensive financial plan, you can learn more or schedule a consultation at Targeted Wealth Solutions.

Disclaimer: the material in this blog post is intended for general educational purposes only and should not be considered specific financial advice. You should always consult with your personal financial advisor to see how it might fit within your personalized financial plan.