Given a tax advantage account and a non-tax advantage account, should trades be concentrated in the tax advantage account?

Question

TL;DR: If my investing strategy is a mix of ETFs (50% value, rarely traded) and stocks (50% value, more frequently traded), is it advantageous to do the stocks trading in the tax advantage account and the ETFs in the non-tax advantage account?

I have both Roth 401k and a regular after tax brokerage account. The relative portfolio weights are 40% Roth 401k, 60% brokerage. I invest in ETFs and pick a few stocks in sectors where I believe in the long term outlook. I'm in high tax brackets and in CA which has high taxes. Most of my trading is long term but recently and especially with 2020 I've had more short term moves. I'm considering doing all my "day trading" in my Roth 401k to avoid cap gains taxes and putting my brokerage all in ETFs. Is this smart or is there a reason not to do this? Will this result in better returns due to taxes (including when I finally cash out retirement in 30 years)

Answer 1

Yes, that sounds like a fine plan. In the case of a traditional IRA, making a trade and then not paying taxes on the gains is like getting an interest free loan in the amount of the taxes you would have paid. You can then invest that money and earn a return on it, eventually repaying the loan when you withdraw the money at retirement. All the returns you made on that tax-free loan is "free money".

In the case of a Roth, you don't even have to repay the loan: you've already "paid the loan" through the ordinary income tax you've paid on the principal. This means with a Roth you are starting at a disadvantage compared to a traditional IRA, but any taxes you are able to avoid by conducting trades in a Roth IRA are effectively "free money", which you hope will eventually offset the initial disadvantage. (It may not, especially if your savings rate is high and/or you plan to retire sooner rather than later.)

One reason to not put your day-trading assets in a tax-advantaged account: you may have other assets which are even better placed there. For example, a common strategy is to hold bonds and REITs in a tax-advantaged account because these investments generate significant, regular income which is taxed at regular income rates. Of course, whether it's better to use your limited IRA accounts for bonds/REITs or day trading depends on the returns of each, which will vary depending on market conditions and your success or lack thereof as a day trader.