Is it clever to balance a portfolio across different account types?

Question

I thought about how to balance my portfolio between low-risk and high-risk investments and at the same time between IRA, IRA Roth, and normal investment accounts.

(This question is not about how to get money into or out of IRA and IRA Roth - assume it's already there and shall stay there)

Considering that high-risk investments are expected to bring the higher yield, it seems to be a good idea to have those in the IRA Roth (where the gains are tax-free), and cover the lower-risk/low-yield investments in the normal account (where the gains are taxable).

This seems to be a useful approach, independent of the personal risk-adversity - sort your desired investment types by risk/yield expectations, and make the highest ones inside the Roth, and the remainder in the normal account.

Am I missing anything here, or is this correct?

Answer 1

I've not heard of that kind of approach. One thing that is more common is to have asset classes that spin off cash favored in tax favored accounts. Conversely, have asset classes that spin off little cash in taxable accounts.

For example one might want to put funds, like an S&P500 index fund in a taxable account over those in a fund like FOCPX. FOCPX distributed ~5% of NAV during 2017, with all of it being capital gains. In comparison FUSVX distributed about 2% of NAV with the majority coming from dividends and very little coming from capital gains.

As far as bonds, people tend to hold assets that are income tax free (such as municipals) in taxable accounts and favor holding corporate type bonds in tax favored accounts.

One must consider the goals of taxable investments, but lets assume that we are considering them supplemental retirement accounts.

I think you are "barking up the wrong tree" as far as your approach. For example, lets say you make a "risky" investment that does not pan out well and you must sell at a loss. You would be better off having that in taxable as it would reduce income and the associated tax one owes. No such benefit in a tax favored account.

Even if they are profitable, one can make wise choices at retirement time, as far as taxes, on which assets to sell and which to hold. Taxes can still be avoided on profitable investments in taxable accounts if they are held and not sold.

Really the key in deciding which assets should go in which type of accounts is the rate at which they spin off cash. You want those that spin off a lot of taxable income in tax favored accounts.