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Money For the Rest of Us
Asset Location: Where You Invest, Where You Live, What You Can Access
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Welcome to Money for the rest of us. This is a personal finance show on money. How it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today is episode 550. It's titled Asset Location. Where you invest, where you live, what you can access. Recently Leperell and I were in South Florida. And the first night we stayed in Coral Gables. And being there reminded me of a client that I used to have in Coral Gables. This was a medical malpractice insurer. I'd only been an institutional investment advisor a couple of years and boy was I in over my head. This was a client that had a, had a board that was made up of doctors and they ran this small medical malpractice insurer. And most of my experience in working with clients at that point had been university endowments, foundations, clients that didn't care about taxes because they didn't pay taxes. They were not for profits. This was taxable, this insurance company. And they were very concerned about after tax returns and after tax income. And I found myself because I was both an advisor, but I also had to do some analysis, taking their performance and tax, adjusting it, taking the income and reducing it by the taxes and any gains. And it was very manual. But the entire approach to investing was different because of this focus on what is the after tax income. Now that's not that much different than what we face as individual investors, but it often isn't at the forefront as we talk about asset allocation, which is about dividing financial assets into different categories based on their expected return and risk. And then we decide, well, how much do we allocate to stocks versus bonds versus versus real estate? And we're trying to build a diversified portfolio. Asset location is different. It's focused on deciding which type of account those assets should be placed in in order to maximize the after tax return on the portfolio. And so we have taxable accounts like a regular brokerage account. We have a tax deferred account such as a 401k plan, an individual retirement account in the US and then there are tax free accounts such as Roth IRAs where there's no taxes on the income on real gains or withdrawals. But with a tax deferred account, there also isn't taxes on the income and gains, but you're taxed on any withdrawals from that IRA or that tax deferred account. And then the taxable account, all kinds of taxes both on income and gains. And so this medical malpractice insurer, they were taxable and they were very focused on how do we maximize our after tax income. Now I've been focused on asset location. I realized while I've covered it in plus episodes, I've never really done a regular podcast on it.
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And I wanted to sort of review.
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All the literature again to make sure that we're being effective in teaching the principles of asset location. Because one of the things that we're working on that we'll potentially do is a live portfolio building workshop in terms of helping individuals to actually implement portfolio rebalancing or creating a new portfolio and helping individuals do this as a live cohort over three to four weeks. And so as part of that, that would involve some discussion on asset location. But before I share those asset location principles, I wanted to zoom out a bit and consider where asset location fits in the broader context of our lives. I have shared a quote in the past by Henry David Thoreau, the philosopher. He was a walker. He would walk for hours every day, and he said, no wealth can buy the requisite leisure, freedom and independence. And which are the capital in this profession, the profession of walking. Now, we usually think of capital as a financial asset, but for Thoreau, he inverts it. Capital for the walking profession is leisure, freedom and independence. And as I've been working on this next book, I've been writing recently about a capital reservoir that we have. This reservoir includes our freedom and independence, as Thoreau says, but also our skills, education, health, mobility, savings, time, our experiences, relationships, our life energy. You have this huge reservoir of capital and what capital does. These are assets that we have, both tangible and intangible, that expand our choices, give us more opportunity. This capital is all that we have been gifted and accumulated during our lifetimes. And as our capital grows, because capital expands our choices with more capital, our capacity to live more abundantly expands. And so that's kind of the metaphor for this capital reservoir. But with something like that, there's a temptation to optimize it. When we optimize something, we're seeking the best solution that satisfies a given goal, subject to constraints. If we're trying to optimize asset location in a portfolio, we're trying to maximize our after tax returns given the constraints of the various investment types that are there. The taxable, tax deferred and tax free. But when we think about our reservoir of capital that contains all of those things, skills, education, mobility, health, that's not something that we can optimize because it's, it's so expansive and it can't be Flattened out into a mathematical formula because there's a lot of intangibles in there. So what we're trying to do with our capital reservoir is to calibrate it to make sure that we're understanding the trade offs that we face every day. Should I expend some of my life energy to purchase this new television? Will doing so increase my abundance? Should I spend time taking a new course to learn something new? Is that worth my time? So one of the things in our reservoir capital is, is mobility and where we live. And I thought about this recently. Le Pearl and I drove from Tucson to Palm Springs a couple weekends ago. We drove along Interstate 8 and that highway passes through Yuma right there on the Arizona California border where the Colorado river is. And right across there in California, these hu sand dunes and the desert San Verbana and the desert primrose was, was blooming everywhere. It was, it was a super bloom. It was super gorgeous. But before you hit the sand dunes, you get to this stretch that there's all of these billboards for dentists and they're for dentist in the town of Algodones. It has a population of 5,500. But there are 350 dentists on one street in this Mexican town. And they're located there because Americans go across the border to get dent care. Los Algodones is sometimes called Molar City. 1.3 million Americans traveled to Mexico for medical care in 2024. They spent about $430 million in the border economies on both sides of the border. So there in Mexico, there's human capital of dentists that have set up their practice to assist Americans that want to go to Mexico for root canals or other medical procedures because it's less expensive to do so in Mexico. That was an asset location decision for those dentists and a mobility decision for Americans going there to get dental care.
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That's JoinDeleteMe.com David20 code David20 now we kept driving on that road and we reached the Imperial Valley. Imperial Valley is just below the Salton Sea. It is a huge agricultural region that supplies 90% of the winter vegetables consumed in the U.S. think lettuce, spinach, broccoli, cauliflower. And the farms are huge and they're irrigated from water that flows from the Colorado River 80 miles via canal to irrigate this valley. Now, I used to live on the other side of the Imperial Valley, on the Mexican side in Mexicali. And I had some acquaintances that every day she would get up and she would cross over the border into the US and she would work in these fields. Even Today, there are 15,000 farm workers that cross every day from Mexico into the US to harvest these vegetables, especially during February and March. In fact, all across the US there's 2.4 million hired farm workers. These are migrant seasonal workers. They are part of guest worker programs. Some are legal, some illegal, but we have this flow going across the Mexican border and Mexicans flowing in to the US because of the opportunities to access human capital, to expand human capital, human capital being our skills that we have that are employable. Now, there's a research paper that I stumbled upon in researching asset location. I often will go to the Social Science Research Network and I put an asset location and I'll be honest, there. The search functionality of that website is not great. And so I get all these papers that have nothing to do with what I'm actually looking at. But this one was by two academics, one from University of Chicago, the other from Princeton. And I'll link to it in the show notes and they write. Few decisions shape an individual's life more than the location decision where they where they live. There are spatial differences in job and schooling opportunities and amenities. And the more desirable places with greater opportunity have higher rents and higher housing prices. And we all know that. But they, they point out that life prospects for a kid growing up in Palo Alto are staggeringly different than those for someone growing up in central Detroit, even if they come from similar backgrounds and go to the local public schools. So their question is why do some people fail to move to locations that offer the best prospects for them and their families? And some arguments are, well, it costs money to move. They don't want to give up friends and family and they might have connections, but they look kind of look at it financially. They see where you live as an asset investment decision. And when you buy more of that asset, that location asset, by moving to a better location that costs more today, but you get better returns in the future, you're able to better expand your reservoir capital, your connection to relationships, the networking opportunities, the education. On the other hand, we can reduce our costs today by moving to a cheaper location, potentially at the expense of future opportunities. And that can be really challenging because moving has higher upfront cost and we're.
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Often wired to minimize cost today and.
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Not worry so much in the future. And we often don't think about that in terms of where we live. Joshua Sheets and I talked about that a year ago when we were talking about living overseas. And he says, or said that oftentimes when individuals relocate overseas that, yeah, they reduce some of their costs, but they don't realize what opportunities are also giving up in an example he gave is something as simple as having access to books. In his case, they he buys a lot of books as he homeschools his six kids. And so anytime he would come back to the US From Costa Rica, he was always getting a bunch of books and then carrying them back with them because Amazon didn't deliver in Costa Rica. So there's trade offs about where we live. Some places are less expensive, but potentially there's a future cost to that. One other paper, briefly, that has to do with asset location and it relates to adapting to climate change. And I'll link to this paper by Wackernagel and Raven. And they say the takeaway is simple. If you want to succeed in a future defined by greater climate disruption and fewer resources, prepare for it. This means reducing your dependence on resources such as fossil fuels, which are becoming perhaps more scarce, but certainly more costly. And so if one believes that climate change will have an impact in raised cost, such as in more vulnerable areas, and we're seeing it in the price of home insurance, do we act now? Think of it as an asset decision. How do I build a more resilient life resilient portfolio in the face of potentially higher cost acting on one's best interest? Better to adapt now and be more resilient now because of this future disruption. We've done this in terms of our move to Tucson, which also gets water from the Colorado River. Colorado river is 1440 miles long and seven states access it. You have upper basin states of Colorado, Utah, Wyoming, New Mexico and lower basin states of Arizona, California and Nevada. And Tucson gets its water from the Central Arizona Project. So it pulls water from the Colorado river, takes it all the way over there north of Yuma on the California border, brings it all the way across to Phoenix and then down to Tucson. There's something called the Colorado River Compact where these seven states and Mexico and a number of Native American tribes allocated 16 and a half million acre feet of annual water flow. But the actual natural flow of the river is closer to 12 million acre feet and it's been falling to about 10 million acre feet. And there's been lengthy negotiations in terms of who's going to get cut and how much. And it's going on and on. They can't come to an agreement. Potentially have to be federally mandated. But again, this is another example of a scarce resource that's becoming more scarce, that asset decisions and cost have to be allocated. So we do this all the time in our life and in our investing. Before we continue, let me pause and share some words from this week's sponsors.
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Are the principles of asset location when it comes to our specific portfolio? Now again let's review the different types of accounts. There are tax deferred accounts that you can contribute pre tax ongoing, it's tax free and then when you withdraw the money it's tax. So a 401k plan, 403b plan, it could be an individual retirement account. There are tax exempt accounts where you put after tax contributions ongoing, the income and realized gains are tax free and then you withdraw on a tax free basis. And a Roth IRA and a Roth 401 are examples of those tax exempt accounts. In the US we have taxable accounts where you contribute after tax funds, they're taxed on an ongoing basis and then if you withdraw by selling assets your gains are taxed and that's a traditional brokerage account. And we were talking about this episode in our family and my son in law says well then there's the mattress and what do you allocate under the mattress and it could be your gold or cash or whatever different asset location decision. But in looking at the research, one of the underlying principles is we should treat all of the different types of accounts as one unified portfolio. So instead of doing a separate asset allocation for our four plan And a separate one for our taxable brokerage account. We combine them all together into one portfolio and doing so is much more tax efficient because we're making asset location decisions across the entire portfolio rather than trying to keep the same allocation within each silo. And we, we facilitate doing that on money for the rest of us plus membership. We have an asset allocation spreadsheet where members can divide up their portfolio by dollar into the different buckets, the different asset categories and at the end it spits out an expected return and range of returns and a risk in terms of maximum drawdown and the recovery period. But we look at the entire portfolio, all the different types of accounts, and that isn't necessarily traditionally done, but it is the most efficient if we're trying to maximize our after tax return. In fact, there's one paper by Morningstar where they suggest as part of that asset allocation decision we should actually tax effect those assets. So if we have assets in our IRA then we think it's going to be distributed. We should lower the balance by the amount of taxes that we'll owe or, and there's many different ways to do this, most people don't, but they suggested if we have an element of portfolio that's going to be reduced due to taxes, they're suggesting we should, should do that analysis and then do the allocation. Otherwise our percentages could be different if we don't. I'm not quite sure I buy into that, but that, that was an interesting, intriguing approach. So that's the first principle. Treat the entire set of accounts as one unified portfolio. Now the most tax advantaged account are the tax free ones. They're incredibly powerful which means our highest returning assets generally stocks should be in that Roth IRA that tax free because we benefit from the compounding. We don't have to taxes on the gains if we sold it. And that it is so powerful with a Roth IRA that we don't want to put another asset in there that just generating income and doesn't have as high of a return because we're trying to maximize that compounding because we can pull out without having to pay capital gains tax. So for the tax free accounts generally it should be all stocks or assets just with a high expected return for the tax deferred assets because we're not paying taxes on an ongoing basis, but only when we withdraw, we want higher income, higher turnover, higher capital gain strategies in that tax deferred account. And so taxable bonds, high yield bonds, closed end funds that have high distributions, equity REITs, these holdings that generate a lot of taxable income and capital gains tax distributions. They should be in the tax deferred account account. That would also include bond ladders or a TIPS ladder. I'll link to one paper where they talked about that asset location decision for and they looked at well, where should TIPS ladders be? And you don't want them in your taxable account because of there's some phantom income there as the principal is adjusted for inflation. You don't want them in your Roth or your tax free account because that TIPS ladder isn't generating a high return. We want to reserve that for our highest returning assets assets. So a tax deferred vehicle is the preferred location for a TIPS ladder. And then for a taxable account we want lower portfolio turnover. So assets that aren't generating a lot of capital gains distributions but aren't necessarily generating a lot of taxable income either. So that could be municipal bonds for example, but it also could be stocks index. ETFs could be direct indexing where they're doing some tax loss harvesting in order to reduce their after tax income. But that's what should be in a taxable account. Lower turnover. Assets that aren't generating a lot of income. But it can be stocks. And that's. So when you think about it, that's challenging. We can put stocks in the Roth. You can also put stocks via ETFs which tend to be very tax efficient in a taxable portfolio. Higher income strategies tend to be in our tax deferred portfolio. But we have all these other assets and it's not something that could be optimized necessarily. And I'll share that in my portfolio here in a minute. Now, what about your mattress? What about your escape hatch? It's okay to have some cash and gold or Bitcoin and keep that completely separate, not linked to financial accounts. Keep some of our assets apart from the financial system. And again, these are just financial assets.
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We have all kinds of assets that.
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Are part of our capital reservoir. Now I was looking at my portfolio and I do okay with asset location. I don't have a Roth IRA at this point. So we basically have taxable account and a tax deferred account, a regular ira. And every year we've been looking at close closely at should we do some Roth conversions, taking some of that IRA money and move it into a Roth. We're at that age where it can be advantageous to do so. But if I look at my taxable account, I have preferred stock in my taxable account account. And why? Well, because one of the things I look at is as part of my overall allocation, when I look at the yield on this preferred stock and it's yielding 8.8.5% because it's mortgage REIT preferred stock after adjusting for taxes, it's still an attractive yield. It's a yield higher than I could get with municipal bonds. Same for the CLOs and some bank loans that I have in my taxable account. But I'll be honest, I have a mix everywhere and I need to do a better job personally in asset location. And we'll do that especially as we potentially do Roth conversions. But it's a work in progress and you can't optimize it. But if you understand the principles that we've covered, which is the highest returning asset is in your tax free account, your Roth cause there is no taxes ever and you want to benefit from that. Compounding your tax deferred, your higher income, higher turnover, higher capital gain strategies, your bonds, your high yield bonds, your closed end funds, your equity REITs, your tips ladders and your taxable could be municipal bonds, it can be some stocks, direct indexing, indexing, ETFs, muni bonds and those are the asset location principles. Hopefully you have found this helpful. Hopefully you think about your pool of assets is much broader than just your financial assets. Your capital reservoir includes your human capital, includes your relationships, your network. It includes your ability to choose where you live and where you go to access services, including perhaps leaving the country to access medical services or something like that. All part of a capital reservoir which is we really can't optimize but we can kind of calibrate and that's the best we can do. That's episode 550. Thanks for listening. We've made some exciting changes to money for the rest of us.
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Plus our model portfolios have been updated and are better tuned to help you confidently make or rebalance your ETF based investment portfolio. Plus membership now includes nine model portfolios.
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Learn more at moneyfor the restofus.com join. That's moneyfortherestofus.com J O I N Everything.
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I've shared with you in this episode's been for general education. I've not considered your specific risk situation, not provided investment advice. This is simply general education on money investing in the economy. Have a great week.