Growing your portfolio isn’t only about selecting the right investments; it’s also about maximizing how much of the gains you can keep and minimizing how much you have to give to the government. Therefore understanding the tax implications of your investments is a key part of taking control of your wealth. Fully utilizing tax-advantaged accounts (such as 401k and IRA accounts) is important, but it’s not the only step in achieving better after-tax investment returns.
Different investments can be treated very differently by the taxman. Dividends from stocks (or funds that invest in stocks) are generally taxed at a much lower rate than interest payments from bonds (or funds that invest in bonds). Funds that have a high “turnover” (meaning they frequently rearrange their underlying investments) will often generate more taxable income than funds with lower turnover. Most income from municipal bonds is exempt from federal income tax (and sometimes state income tax too).
If you have a mix of tax-advantaged accounts and regular accounts, you can benefit from the tax differences by putting more of the high-tax investments in the tax-advantaged accounts and the low-tax investments in the taxable accounts. This tactic is called “asset location” (you’re locating your assets in accounts where they’re most efficient from a tax perspective). Done properly, it can let you retain more of your wealth and make it easier to achieve your financial goals.