Forget About Asset Location: Why You Should Hold The Same Asset Mix In All Accounts
Much has been written about optimizing your portfolio(s) for tax efficiency by placing certain investments or asset classes in certain accounts. This tax planning strategy is called asset location.
In this article I’m going to explain what asset location is all about, what optimal asset location can achieve, and why you should forget about it and just hold the same asset mix across all your accounts.
What Is Asset Location?
Most investors know about asset allocation – the mix of stocks, bonds, and other asset classes (gold, real estate, etc.) used to build a portfolio. For example, a classic 60/40 balanced portfolio would hold 60% stocks and 40% bonds.
But what happens when you hold investments inside an RRSP, a TFSA, and maybe a LIRA from a previous employer? What happens when you add a taxable or non-registered investment account to the mix?
This is where asset location comes into play. Asset location is about determining which assets to hold in each account. Why? Two reasons:
- The returns from capital gains, interest, and dividends are all taxed in different ways.
- Each of your accounts (RRSP, TFSA, non-registered) have different tax rules.
I’ll summarize what Preet Banerjee wrote in this 2013 MoneySense piece (“Everything in its place“):
- Interest income earned from savings accounts, GICs and bonds is taxed at your highest marginal rate.
- Capital gains are taxed more favourably and only when the gains have been realized (i.e. when you sell). You’ll pay tax on 50% of the gain – again, at your highest marginal rate.
- Canadian dividends get special treatment with the dividend tax credit, with a greater advantage to those in a lower tax bracket.
- Foreign dividends are taxed at your highest marginal rate, just like interest. Many countries also impose a withholding tax on dividends paid to foreign investors – most notably the 15% foreign withholding tax on U.S. dividends.
Many investment advisors look for ways to optimize asset location to better take advantage (or lessen the disadvantage) of these different tax treatments. They accomplish this by placing certain assets in either a tax-deferred, tax-free, or taxable account:
- An RRSP is a tax-deferred account, meaning all investment growth (from capital gains, interest, and dividends) is sheltered from tax until withdrawal. RRSPs are also exempt from foreign withholding taxes on U.S. dividends.
- A TFSA is a tax-free account where all investment growth is sheltered from tax and future withdrawals are also tax free. Foreign withholding taxes apply and are not recoverable.
- A taxable account is a non-registered account where any interest and dividend income is taxable in the year it’s earned. Capital gains are taxable if and when they are realized. Foreign withholding taxes do apply, but they can be offset by claiming a credit on your tax return.
An optimal asset location strategy puts interest-bearing investments (fully taxable in the year earned) into a tax-deferred or tax-free account. It puts Canadian stocks and preferred shares in a non-registered or taxable account. Foreign dividend paying stocks (particularly U.S. stocks) go into a tax-deferred account. Same with REITs, thanks to their not-so-tax-efficient income.
In summary:
- Bonds, GICs, high-interest savings – RRSP or TFSA
- Canadian stocks and preferred shares – Non-registered (taxable) account
- U.S. and foreign dividend paying stocks – RRSP
- REITs – RRSP or TFSA
What Does Optimal Asset Location Achieve?
In a 2013 paper from Morningstar, the authors determined that an optimal asset location strategy might lead to a 0.23% per year increase in after-tax returns (versus holding the same asset mix in each account).
In a 2014 paper, PWL Capital’s Justin Bender and Dan Bortolotti looked at an ETF portfolio held from 2003 – 2012 and found that optimal asset location would have added 0.30% per year to the after-tax returns.
Finally, in a 2017 paper, PWL Capital’s Ben Felix found that optimal asset location could ideally add 0.23% per year to after tax returns.
In a world where ETF investors change portfolios just to save 0.25% per year in fees, striving for an optimal asset location strategy to increase after-tax returns by as much can sound compelling.
Unfortunately, once again what looks optimal on a spreadsheet can prove to be impossible to manage in real life. As Ben Felix explains, the analysis is based on expected future returns, which are unknowable in advance. Other issues include:
- Regulatory risks – What if tax rates or other tax laws change?
- Room for error – Given all the future unknowns, even financial professionals and academics often heatedly debate just what qualifies as “optimal” asset location.
- Added complexities – Obviously, it takes a lot more time and energy to engage in asset location than to simply duplicate the same asset allocation in each account. Is the potential value-added worth it?
- Debilitating distractions – Asset location may cause more harm than good if it distracts you from other investment best practices, such as remaining fully invested and engaging in periodic rebalancing.
The bottom line: investors should be wary of going too far down the asset location rabbit hole. It’s allowing the tax tail to wag the investment dog.
Forget About Asset Location
Asset location is an idea that sounds good in theory, but can be a nightmare to manage in practice.
First of all, asset location shouldn’t be a concern at all for investors who only contribute to an RRSP and/or TFSA – especially if the portfolio is small. The asset location question should only come into play once your tax-sheltered accounts are maxed out and you start to hold investments in a taxable account.
Also, investors have been beaten over the head with the idea of optimal asset location that many are either:
- paralyzed to make an investment decision for fear of making a mistake, or;
- overcomplicating their portfolios and making them impossible to manage.
So, what’s the solution?
Forget about asset location. That’s right. Forget it.
Instead, simply hold the exact same asset mix across all accounts. That means if your ideal asset allocation is 60% stocks and 40% bonds, then the simplest and most effective solution is to hold the exact same 60/40 portfolio in your RRSP, TFSA, and non-registered accounts.
My own target asset mix, for now, is 100% equities and so I practice what I preach and hold Vanguard’s All Equity ETF Portfolio (VEQT) in each of my RRSP, TFSA, and newly set-up LIRA.
In fact, asset allocation ETFs like Vanguard’s VBAL (60/40) and VGRO (80/20) are ideal for investors who want to hold the same asset mix across all accounts and don’t want the hassle of monitoring and rebalancing their portfolio.
Final Thoughts
Can an optimal asset location strategy add value? In hindsight, the evidence showed that optimal asset location might have increased annual after-tax returns by between 0.23% to 0.30%. But “optimal” also meant an investor in the highest marginal tax rate who executed the strategy perfectly over many years.
Related: 5 investing rules to follow in good times and bad
In reality, there are too many future unknowns and too much room for investor error to conclude that optimal asset location is a strategy worth pursuing.
Instead, my advice is to forget everything you’ve read about asset location and instead hold the same asset mix (i.e. the same portfolio) across all accounts to reduce complexity and behavioural bias.
The asset location strategy you described only looks optimal if you ignore taxes in your asset allocation. The excess return comes from taking added stock risk compared to a portfolio with the same allocation in every account. Taking into account taxes properly, this asset location strategy is almost the opposite of optimal. Justin Bender explained these issues well in his recent blog series. His main reasons for using this asset location strategy for his own clients are regulatory compliance with risk measures that ignore taxes, and investor behaviour. No DIY investor who understands these issues would ever use this asset location strategy (your recommendation to just use the same asset allocation in every account is far superior).
However, the asset location strategy in Justin’s final post (the “Plaid” portfolio) is a potentially reasonable option for those with sufficiently large portfolios to make the extra work worthwhile.
Hi Michael, for sure there can be asset location value in a proper and professionally managed portfolio like the ones Justin and Dan implement for their clients. I’m just not convinced anyone besides the most sophisticated DIY investor can successfully implement it on their own.
So, unfortunately, even excellent posts like Justin’s that speak to a tiny fraction of investors capable of doing this also adds to the noise for the rest of the crowd who will be prone to the “errors, complexities, and distractions” that Ben outlined.
This post is aimed at the vast majority of DIY investors who would be better served to ignore everything they’ve ever heard about asset location and just hold the same portfolio across accounts. It’s not meant to dunk on anyone who feels the extra effort and complexity will add value to their own portfolio.
I think you missed the point of my comment (or more likely I was unclear). Justin and Dan actually use a very sub-optimal asset location strategy that is forced on them for two reasons. One is that regulatory risk measures require that taxes be ignored. The other is that their clients don’t understand that their RRSPs aren’t all theirs. An optimal asset location strategy is almost the opposite of what they are forced to use. I explained all this in a recent post:
https://www.michaeljamesonmoney.com/2020/04/asset-allocation-should-you-account-for.html
That said, it’s still reasonable for investors to ignore an optimal asset location strategy (as you argued). But the calculations of what you’re giving up if you optimize asset location should be based on a sensible asset location strategy, not a bad one.
Hi Michael, you’re right – I missed your original point (more specifically, I missed the point that the portfolios Justin and Dan implement for clients are actually sub-optimal versus something like the DIY “Plaid” portfolio or one that takes taxes and gov’t share of RRSP into account).
Totally get it now and thanks for clarifying.
Michael, I understand what you are saying and agree. However, I do keep only bonds in my RRSP and don’t tax adjust (mainly because I started that way before I understood these things and it’s too difficult to change now). However I like the fact that my RRSP only has bonds in it because, as I know I only own half of them, I’m tricking myself into a higher equity allocation than I could hold otherwise. I also like the fact that if the government owns half my RRSP, I’d rather bonds be in there than my stocks, and with lower RRSP assets due to all bonds, there’s lower RRIF withdrawals, so it’s easier around OAS clawback. I also think that tax adjusting your portfolio is difficult for many DIY investors, especially when it comes to rebalancing.
So I don’t think it’s terrible to prioritize bonds in your RRSP, so long
as you don’t tax adjust the portfolio so you get the boost of having a higher equity allocation than you realize. Better still is the simplicity of the same asset allocation in all accounts, preferably with the single asset allocation funds to avoid having a large number of funds. Except if you have a Corporate account in which case I think Ben Felix agrees there may be a role for asset location.
Hi Grant, It seems that we differ in a number of ways. Once I realize I’ve been tricking myself, it no longer works. It may feel good to think the government is getting a crappy share (bonds instead of stocks), but this feeling melts away for me when I focus purely on what I’m getting (after tax) and not caring about what the government gets. Lower RRIF withdrawals means lower income in retirement. I could have achieved this by simply giving away some of my money instead of making a past RRSP contribution. On one level, more OAS clawback means you have more money to live on. Further, I can reduce OAS clawbacks by making RRSP withdrawals in my early retirement before my OAS and CPP kick in. It’s true that after-tax rebalancing is challenging for many investors. But using the same asset allocation in every account gives better results than filling one’s RRSP with bonds (for the same overall after-tax asset allocation).
The bottom line for me is that I can spend more today and throughout the rest of my life because of my asset location choices. Your mileage may vary.
Hi Michael. What I mean is that the volatility reduction of 60/40 with bonds in the RRSP is really a 75/25 portfolio if tax adjusted. If I had a 75/25 mix, that would exceed my comfort level, yet the 60/40 with bonds in RRSP gives me expected returns of a 75/25. It still works even though I know about this behavioural issue. As for RRIF withdrawals, I’m still maxing out my RRSP (all in bonds) and saving the same amount in other accounts, so no reduction in savings, but by having a lower RRIF withdrawal it’s easier to minimize OAS claw backs. So there is no reduction in retirement income, and may be an increase due to less OAS clawbacks. I’m not doing early retirement, so no point in making early RRSP withdrawals. So in my circumstances and risk tolerance, I can have have a higher expected return for my tolerance of volatility, and therefore a higher income in retirement due to that higher expected return and to less OAS clawbacks. Please correct me if I’ve misunderstood any part of that.
Hi Grant, Your after-tax asset allocation (ATAA) is 75/25. If you maintained this ATAA with a different asset location strategy (no bonds in RRSPs, etc.), then you’d have more money in retirement. There would be a lot of complications in proving this, including OAS clawbacks, but the end result would be more after-tax money to spend. The existence of OAS clawbacks might make the gap between these two choices a little smaller, but for a constant ATAA, your asset location strategy would lose.
However, if we compare your portfolio to one with a 60/40 ATAA, your portfolio would come out ahead, regardless of what the 60/40 portfolio did with asset location. Again, demonstrating this would involve complications, but that’s what the end result would be.
My comfort level is driven by my ATAA. Yours, like most people, is driven by a different risk measure. If you were a family member coming to me for advice, I’d try to get you to see your portfolio differently so that your comfort level would come more into line with your ATAA. For example, one thing I do is to view my overall portfolio in a spreadsheet that only presents after-tax totals. So, I rarely see pre-tax totals. Maybe this could help you. As long as your comfort level remains linked to pre-tax figures, you’re leaving money on the table. If this can’t be changed, then you’re doing the right thing to maximize your retirement spending.
Hi Michael,
How does this work for your wife if something happens to you and your spreadsheet stops working.
I would be rather worried if I were her.
Hi Emily,
It’s interesting that you assume my wife doesn’t understand our investment strategy and played no part in forming it. Those assumptions are false.
However, if she weren’t an engineer with a strong mind for finances, I would have made some preparations in case I die before her. To start with, without my expenses, she’d be awash in money far exceeding the amount she’d spend on herself. So, short of the worst mistakes, she could manage the money in just about any way and be fine. I’d lay out a simple (but sub-optimal) plan that she could follow easily after I was gone.
Fortunately, because of her considerable skills, that isn’t necessary. She already understands enough about our finances to keep them going herself.
Hi Michael,
I see that I was wrong to assume that.
In any case good for you and your wife. You guys seem to appear financially intelligent. My husband and I are not.
I should rephrase that I would be freaked out if my husband felt the need to design our portfolio as such.
I have zero desire to be right about things. I was trying to point out that many of us want things simple.
Michael, I agree. So do you mean if I had a spreadsheet displaying after tax totals, (75/25) that would show a volatility of a 60/40 portfolio? Because that’s a key point in staying invested – the volatility.. If so, that would work, but I don’t think that would be the case, at least with the same asset allocation in all accounts. At any rate changing the asset location after many years, so a lot of embedded capital gains, would be too expensive having to crystallize capital gains.
What a relief! I can stop worrying about which investment goes into which account. I’ll just put my preferred allocation. in each. Thank you, Robb.
Hi John, glad to provide some clarity for you and your investment decisions.
Great article, great advice. I’m loving the simplicity of xbal.
Hello, thanks for your newsletter; always great articles. I am nearing retirement and I would like to see an article about how to live off these investments I’ve been saving for years. I have some money. How do I turn my nest-egg into income? I’ve been told I need some high-dividend income ETF’s; using the dividend cash vs. just drawing off the principle. Are there some low risk auto-re-balancing ETFs I could hold to achieve this or am I barking up the wrong tree?
Donna, here’s an excellent article on cash flow in retirement.
https://www.moneysense.ca/save/retirement/a-better-way-to-generate-retirement-income/
Since I have a DB pension, I realized that impacted my equity v fixed income ratio. I count all pension money as fixed income so all my personal investments are equity (stocks and ETF’s) with no bonds or GIC’s allowed. I agree with you that most investors don’t need to bother. Just get the money into an account. Great summary of the benefits of the three main accounts.
Curious how you determine what value to assign to your DBP?
Simply divide estimated annual pension by total anticipated annual income.
DB pension income = 45K
annual income = 70K
45K/70K = 64.2%
That is my fixed income portion from my pension.
When I add CPP and OAS in a few years the fixed income ratio gets even higher
DB pension = 45K CPP = 9K OAS = 7K
Total is 61K/80K ( Gave myself a raise) = 76%
I believe that those fortunate to have solid DBP can think differently from mainstream advice. You have probably heard the rule that as you age you should have a higher ratio of assets into fixed income. That makes sense for the majority of workers who don’t have pensions but not those of us that do.
All of the above is impressive. My asset allocation remains 100% equities ( 2%<10% on market value and a calm reaction to market blowups. Cash needed for current plans is “not investable “…not in the mix.
The result has been simple, easy to manage (well, RRSP, RRIF, TFSA, trading accounts for both of us plus non-Canadian companies do make for work at times) and quite successful. I now judge success by the measure of “current net worth/ gross lifetime earnings during the 27 years when I worked”. That number remains well above 1x. My forecast of cash requirements, an important element, has always been good, maybe a bit early.
I have no plan to add fixed income assets (bonds) to my holdings. When I “diminish in mental capacity”, one of my children will take over…likely exchanging direct holdings to Equity ETF’s.
Thanks Robb, This adds a marketing point for us. We arrange portfolio management for our clients for only 0.34%. That makes this service almost free if the increase in results are anywhere near .30%, since we always practice asset location. Thanks again
How does this relate to rebalancing strategies? I keep the same asset allocation mix in all my accounts so that I can sell bonds/stocks as needed and rebalance.
If you are using an agressive location strategy you can’t rebalance. When there is a stock correction, all your bonds in your RRSP, so how do you sell and top up your taxable account that has dropped? If stocks are way up how do you sell and buy bonds if your RRSP is full?
Hi Dan, your example helps illustrate my point about holding the same mix across all accounts. Rebalancing is more difficult and maybe impossible. Plus you have contribution limits to contend with in both your RRSP and TFSA.
If you have all bonds in your RRSP, when the market crashes, sell the required amount of bonds and buy stocks. When the market recovers, sell the stocks in your RRSP and buy back bonds, so you are back to your original mix. Stocks generally rise more slowly, so you can add bonds to you TFSA/taxable account as part of your regular savings to keep your portfolio in balance. It’s rare in the accumulation phase to have to sell stocks to rebalance, but you could if need be in whatever account you have them in and buy bonds.
Would you suggest XBAL, even with a 7 figure portfolio, with $200k in non-registered?
Hi Scott, I can’t make specific recommendations – certainly without knowing much more about your situation than the one sentence you typed above.
But in general there is no reason to believe that you’d need to “graduate” to a more complicated portfolio at seven figures.
XBAL is a wrapper that contains seven underlying ETFs that represent different geographical areas for both stocks and bonds. It’s wrapped up that way to make it easy for DIY investors, so they don’t have to hold, monitor, and rebalance a multi-ETF portfolio.
You could unbundle the portfolio, particularly in an RRSP, where US-listed ETFs can save you foreign withholding taxes along with a slight reduction in MER. But, again, you need to decide if that added complication is worth the savings.
I am going to resubscribe to your excellent blog Robb! I had come to a similar conclusion a few years back about asset location with the back-of-the-napkin kind of calculations and had written as such to someone at PWL in private communication but always wondered what is the actual math/numbers.
Due to other personal commitments, I stopped reading financial blogs, time to restart.