On any given day, pick up the Wall Street Journal or Barrons and there will be an article that refers to asset allocation. How should we invest money based on the different characteristics in each segment of the market? What percentage of my assets should be in equites, in fixed income, in cash, in private equity, in hedge funds...?
While this is an important conversation and one that we have with our clients regularly, as the answers to those questions change with time and circumstance, we have found that an important question is virtually never discussed. What is the best mix of asset locations? And by locations, we are not speaking about where your equities, fixed income or alternative investments are held. Rather, we are speaking about the fundamental liquidity and tax nature of those investments. How efficiently can access to those assets be gained and how should a plan be structured to create the most financial flexibility, now and in retirement?
All investments have several characteristics (market risk, interest rate risk, liquidity, tax, etc) and yet location for accessibility and tax diversification are often overlooked. When we first meet clients, we find that they have accumulated most of their net worth in 2 or 3 places...their homes, their retirement accounts and if in business, their business equity. While each has it's advantages, they also have their drawbac ks. None are particularly liquid (without expense in the form of refinancing or penalties). Retirement plans, while they have enjoyed certain tax deferrals while being accumulated, become fully taxable (other than Roth accounts) when the money is distributed. And importantly, the timing and amount of retirement plan withdrawals are subject to government regulation so are not completely at the clients' discretion.
The power of proper asset location can enable individuals to mitigate tax rate risk, protect against the emergency withdrawal of needed cash from expensive sources (qualified plans or real estate equity) and guarantee available cash to take advantage of investment opportunities.
In a perfect world, assets will be diversified by asset class, by liquidity and by taxable nature. At Prosperian this is a fundamental part of the conversations we have with our clients. Their future financial flexibility depends on it.
