How to Build a Tax-Efficient Portfolio
Asset location, tax-efficient investing, and how to minimize taxes on your portfolio by placing the right investments in the right accounts.
Most investors focus on what they own. The research, the allocation, the rebalancing. All of that matters.
But there is a second dimension that receives far less attention — one that can meaningfully change how much of your return you keep: where you hold your investments.
Asset location is the discipline of placing different types of investments in the account types where they are taxed most favorably. It does not change your investment strategy. It changes the tax efficiency of that strategy — and over time, the difference compounds.
At Windward, our CPA heritage means tax considerations are built into every investment conversation. Here is the framework we use:
The Three Buckets
Taxable brokerage accounts (brokerage) generate taxes as you go — dividends and interest are taxed in the year received, and gains are taxed when you sell. Long-term capital gains and qualified dividends benefit from favorable rates. But short-term gains and ordinary income distributions are taxed at your marginal rate.
Tax-deferred accounts (traditional IRA, 401(k)) allow your investments to grow without an annual tax bill. Every dollar withdrawn, however, is taxed as ordinary income. Required Minimum Distributions also begin at 73 (or 75 under SECURE 2.0), forcing eventual distributions whether you need them or not.
Tax-free accounts (Roth IRA, Roth 401(k)) grow and can be withdrawn completely tax-free in retirement, with no RMDs for Roth IRAs during the owner's lifetime.
The Asset Location Framework
The goal is straightforward: place each investment in the account type where it generates the least unnecessary tax drag.
In taxable accounts, favor investments that are naturally tax-efficient — broad index funds and ETFs with low portfolio turnover, buy-and-hold equity positions, tax-exempt municipal bonds, and individual stocks where you control the timing of gains. These generate minimal taxable income along the way and benefit from favorable long-term capital gains rates when sold.
In tax-deferred accounts, consider investments that are naturally tax-inefficient — taxable bonds (whose interest is taxed as ordinary income), REITs (which distribute a large portion of income), actively managed funds with higher turnover, and any investment generating significant short-term gains. Holding these in a tax-deferred account shelters the income from annual taxation and lets it compound uninterrupted.
In Roth accounts, utilize your highest-growth-potential investments —growth-oriented funds or any asset where you expect meaningful long-term appreciation. Since qualified Roth withdrawals are completely tax-free, you want the investments with the most upside sitting in the account where that growth will never be taxed.
Why It Matters More Than Most People Realize
The tax drag from holding the wrong investments in the wrong accounts is easy to miss year by year — but it accumulates meaningfully over time. A bond fund generating 4% annually in a taxable account may net 2.72% after taxes for someone in the 32% bracket. The same fund in a tax-deferred account compounds at the full 4% until withdrawal.
Multiply that difference across decades, and the impact on your retirement income is real.
A Few Important Nuances
Asset location is not a rigid rule — it is a framework that depends on your specific situation. A few considerations that affect the analysis:
Your withdrawal timeline matters. If you plan to spend from your taxable account first, the asset location calculus for that account looks different than if you plan to leave it for heirs and benefit from a step-up in basis.
The relative size of your accounts matters. If nearly all your assets are in a 401(k), you have limited ability to implement a multi-account location strategy.
Roth conversion decisions interact with asset location. Deciding which assets to convert — and therefore move from tax-deferred to tax-free treatment — is part of the same analysis.
The Windward Approach
Asset location is one of those planning elements that sounds straightforward but requires ongoing attention. As accounts grow, as withdrawals begin, and as tax laws evolve, the optimal location of each investment can shift. We review asset location as part of our ongoing investment management process — not as a one-time exercise.
If you have multiple account types and have not recently reviewed the location of your investments, it is a conversation worth having.
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This content is provided by Windward Private Wealth Management Inc. (“Windward” or the “Firm”) for informational purposes only. Investing involves the risk of loss and investors should be prepared to bear potential losses. No portion of this blog is to be construed as a solicitation to buy or sell a security or the provision of personalized investment, tax or legal advice. Certain information contained in the individual blog posts will be derived from sources that Windward believes to be reliable; however, the Firm does not guarantee the accuracy or timeliness of such information and assumes no liability for any resulting damages.
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