Protect Your Investment Portfolio from the AI Bubble

The top part of the pink Block Woman block is next to an inflated yellow ballon with black letters AI written on the balloon.

Are you afraid of the AI bubble? That it’s going to burst and devastate your investment portfolio?

Many clients are expressing this same concern. Here’s what they say (with some poetic license):

AI has dramatically driven up the stock price of all the big tech companies. But there’s no there there in those companies. At least, there’s not enough there there. It’s a bubble. At some point, people are going to realize that Nvidia isn’t worth infinity dollars, the bubble will burst, and all those big tech companies will lose a lot of value and any money I have invested in those companies will go <poof!>. And I will be sad. Very sad indeed.

I know market timing is bad, but still, should we be timing the market?

I can’t knowledgeably comment on all the potential damage caused by the proliferation of AI (though, Lord knows, the abuse of the em dash is damage enough!). But I can usefully comment on how to manage the risk of AI in your investment portfolio.

Market Timing Baaaad. You Know This.

Bubbles are definitely a thing. When they burst, it’s horrible. (Hello, those of us old enough to have lived through the Dot Com Bust, especially if we worked in the tech industry at the time and saw all sorts of paper millionaires become paper un-millionaires overnight.) If you could get out of the market right before the bubble burst, that’d be awesome.

But you almost certainly can’t. There are two problems with trying to get out of the market because you’re afraid of a bubble:

  1. If you get out of the market too soon, you risk missing big gains.
  2. Even if you get out at a good time, you risk missing big gains because you don’t get back in at a good time.

There is ample evidence that trying to time the market—in any way—puts you at a severe disadvantage in achieving long-term returns. Yes, the AI bubble might burst in six months…but also some of the best gains ever might occur in the next five.

Imagine getting out of the market earlier this year because of fears of Trump or tariffs or the AI bubble. Look at how the US stock market has performed this year (using the Vanguard Total US Stock Market ETF, ticker VTI, as a proxy for the whole market). It’s up 13.9% as of November 9, 2025. Especially look at how it has performed after the tariffs-induced crash in April. Holy rebound, Batman!

Source: finance.yahoo.com November 9, 2025

Let’s say you are that statistical anomaly that successfully got out of the market at a good time, back in January, because Trump! (Trust me, I feel you.) In April you were feeling pretty darn vindicated. But if you haven’t yet gotten back in because Still Trump! or because of the AI bubble…oh my goodness, you would have missed a lot of growth!

So, if market timing isn’t the answer, what’s a gal to do?

First, let’s revisit some important rules for investing.

What Makes for Good Investing?

While there is boundless commentary on “how to invest” (some of it even useful), I think most people will agree that there’s a short, simple list for the basics of good investing. Let’s discuss some of those here.

For more discussion, read about our investment beliefs here at Flow.

Know when you need your money.

Do you want to buy a house or retire in five years? Or is it in 20? You’re going to invest your money differently depending on the answer.

Why? Because if you invest in the stock market, your investments could lose half their value within one year and not recover the value by that five-year deadline, and you would therefore be unable to meet your goal of home ownership or retirement.

But if you have twenty years to wait before you need that money, you have more time to recover from stock market losses, including an AI bubble burst. Additionally, if you don’t invest in the stock market for a goal 20 years from now, your money will likely not grow enough to be able to buy or retire in 20 years.

Be it too aggressive for a short timeframe or too conservative for a long timeframe, if you invest inappropriately for your timeframe, you risk not having the money you need when you need it.

Know how flexible your goal is.

“Sure it’d be cool to fly first class for that big trip around the world after the kids are old enough to appreciate it, but if we have to fly coach or cut the trip short by a week, I’m okay with that.”

Or

“It’d be the bee’s knees to retire in five years, but I also still quite like my job, so if I have to work another 10 instead, that’d be okay.”

If you can talk about your goals in this flexible sort of way—you’re willing to adjust their price tag or their timing—you can be a little less strict in how you invest for them.

I encourage this framework when it comes to managing a big pile of company stock. If you have a lot of your wealth wrapped up in company stock, it can be very hard to know if you should sell any of it. Even if you know it’s too risky to keep all the stock you have, the lack of a logical strategy for selling it prevents you from doing anything.

Here’s what I usually propose:

  1. Identify the essential goals in your life. Putting your kids through college. That kitchen remodel. Down payment on a home. Full financial independence at age 55.
  2. Tally up how much money you need to fund all those goals.
  3. Sell enough company stock to set aside for those goals (after paying taxes!).
  4. If you have company stock left over after that, then you can be much more flexible about selling vs. holding the stock. You don’t need the money for anything essential, so you can afford to take more risk (by keeping a concentration in this single stock) if you want.

The same logic applies to investing in general: if you have goals that are “nice to have”—not “must have”—I believe you can be more loosey goosey with how you invest for them.

Yes, I still think that statistics work the same no matter your goal, i.e., a diversified portfolio with a balance of stocks and bonds appropriate for the timeframe is the most likely way to grow your money. But if you’re okay with the possibility of not having enough money at the end of the timeframe, you can reasonably choose to invest far more conservatively (you’re less likely to lose as much, but nor will it grow as much) or far more aggressively (maybe it’ll go to the moon! But also maybe it’ll plummet to earth).

Diversify.

Diversification—making sure you own a bit of every kind of investment asset—is the “magic” solution to managing risk in any single company, sector, country, etc.

Do you work at Chime and 90% of your net worth is in Chime stock because the company just went public and all the RSUs you’ve acquired over the last four years just vested? Diversification will reduce your risk.

Is all your money in US stocks, no international stocks or bonds? Diversification will reduce your risk.

More to the point of this blog post: Is all your money invested in the S&P 500 (which is dominated by Big Tech/AI companies) or, more risky, the Nasdaq 100 (even more so) or, more risky still, just a handful of Big Tech/AI stocks?

Yeah…you’re in for a very bumpy ride if/when the AI bubble pops. Aaaaand diversification will reduce your risk.

If, on top of Big Tech/AI stocks, you also own:

  • the rest of the US stock market
  • international stocks
  • maybe even some bonds (whuuut?!)

then all that is money that likely won’t be so devastated by the bursting of the AI bubble.

Write down your strategy.

Let’s say you have a lot of Bitcoin or Google stock. You constantly worry that “something” should be done, but you can’t bring yourself to actually do anything. One of the biggest causes of your paralysis now is that you had no strategy when you acquired it.

As you were acquiring Google stock or Bitcoin, you could have created a reasonable strategy like “If Google stock exceeds 20% of my total investment portfolio, I will sell the excess and invest that in my diversified portfolio” or “Every time Bitcoin’s value reaches another $10k high, I’m going to sell half of that increase and invest that in my diversified portfolio.” Make your own rules, but make sure they are clear. Rules that leave no wiggle room or uncertainty.

For more traditional investment portfolios, with their boring mix of index funds and ETFs, your strategy might look something like this:

For my goal of retiring in 20 years, I am going to:

  • Invest 90% of my money in stocks and 10% in bonds.
  • The stocks are going to be 60% US stocks and 40% international stocks.
  • Furthermore, the US stocks are going to be 80% large-cap stocks and 20% small- and mid-cap stocks.
  • All investments are going to have expense ratios under 0.20%.
  • I am going to check on my portfolio once a year.

You can make your strategy as high-level or as detailed as you want. For example, you could say you are going to invest 90% in stocks and 10% in bonds, or you could say you’re going to invest 3% US small-cap value stocks, 3% US small-cap growth stocks, 3% small-cap blend stocks, and so on through all the various “asset classes.”

The more general the strategy, the easier it is to manage. The less poke-poke-poking you’ll do. The more detailed it is, the more advantage you can possibly get from differences in how each different tiny piece of your portfolio performs. On the downside, you’ll be tweaking your portfolio far more often. And as Warren Buffet purportedly said, “Money is like a bar of soap. The more you touch it, the less you’ll have.”

If you don’t have a strategy, how will you ever know that you have too little or too much of something, and what to do if you do identify a deficit or surplus?

Protect Your Portfolio from the AI Bubble.

What does all this “investing best practices” stuff mean for what you should actually do to protect yourself?

In a word: Rebalance.

In many more words that might actually mean something to you:

Start by ensuring you have a strategy for each life goal. If you don’t have a strategy already, create one. If you are feeling emotional about it (which you probably are, and emotion is the killer of prudent investing), I recommend you hash it out with someone else you trust to be knowledgeable and (relatively) impartial. Hey, like a financial planner!

If you already have a strategy, then I encourage you to review it. Does it still make sense for your goals, both the timeframe and the flexibility?

Then at least every year, and possibly even after major market movement, look at how your actual investment portfolio matches up against your strategy. If it differs significantly, then you need to buy and sell to bring it back in balance. Hence the term “rebalance.”

Is your Google stock worth 30% of your portfolio now? You know you need to sell that 10% excess.

Is your portfolio 60% in the S&P 500 (a Big Tech/AI-heavy index) but your strategy said it should be only 45%? You know you need to sell that 15% excess.

If you have new cash to invest, you might not need to sell anything that there’s too much of. You can use the cash to buy more of what you have too little of. This makes sure that the balance or ratios between all your investments are as prescribed.

If you’ve been invested in the US stock market and haven’t rebalanced recently, you likely are overweight Big Tech/AI companies, simply because they have grown so much in the last year or so. This, in turn, probably means you need to sell some of your Big Tech/big US company stock investments, be it individual stocks or funds that are dominated by those companies.

You can then take that money and buy more of other types of investments: smaller companies, international stock, bonds. Oooh, oooh…even better: take a gander at those inflated values and donate the shares to your local food bank! (You can read more about this strategy in this write-up of how I created my own charitable giving strategy.)

In a way, it really is That Simple.

  1. Create a strategy. At a high level, this dictates how much of each kind of asset you are going to own.
  2. Check if your investments still abide by that strategy.
  3. If you own “too much” of one asset, sell some.
  4. If you own “too little” of another asset, buy some.

After you create the strategy (which yes, involves some level of guessing), there is no guesswork here. No market timing. Just prudent, boring, rational ways to manage risks of all sorts along your investing journey. A way to disconnect yourself from all the anxious hand-waving about AI (at least, from an investment perspective).

This does not mean your portfolio won’t suffer if the AI bubble bursts. It does mean you are more likely to weather any investment storm a little better.

Do you want a strategy for your investments that makes sense to you? That you have confidence in?

Why You Might Want A Professional to Manage Your Investments

Block Woman wears a green visor or eyeshade while sitting next to a desk.

Or “Why just putting all your money in the S&P 500 isn’t enough.”

(Okay, probably isn’t enough. I’m not allowed to say much that is definitive about investing.)

Recently I spoke with a woman who asked, “Can you tell me why I want a financial planner to manage our investments? We just put everything in the S&P 500.”

I acknowledged that, yes, an S&P 500 fund can be a great place to put a lot of your money. Good job! I then proceeded to quickly trip and fall down a rabbit hole (it’s really hard to not do this when talking about investing) describing just a single tactic we can use to improve our clients’ investments beyond picking good funds. (It was the concept of asset location, if you’re curious.) She almost immediately responded, “Oh, I didn’t know about that.”

Whiiiiiich prompted me to write this blog post!

Because while I am happy to observe that many people, especially in the tech industry, have drunk deeply of the “low cost, broadly diversified” waters, I have also observed that many of these same people aren’t aware that way more goes into managing investments well. As a result, they simply aren’t aware of the ways in which an investment professional can be valuable.

I believe that most people can benefit from having someone manage their investments. Call me biased. (‘Cause I am.)

In my opinion, there are two reasons to hire someone to manage your investments:

  1. You don’t want to manage your investments…but you want them to be managed. (Enter stage left: Meg)
  2. A dedicated professional—someone who has been educated in, trained in, and experienced in managing investments, strategizing about how investments interact with other parts of your financial life, and managing human behavior—can do a better job than you.

Let’s dig in.

Reason #1: You don’t want to do it yourself.

Let’s assume for a minute that you have all the knowledge, time, and self-awareness you need to manage your investments well (assumption to be revisited later).

Maybe, just maybe, you want to do other things with your time, energy, and brain power.

Maybe managing your investments isn’t fun, while other things really are.

Maybe your life is busy enough with job and family and obligations, and piling Yet One More Important Thing on top of that fills you with anxiety.

Maybe you’re in a couple, and you think it’d just, well, work better if someone else did this stuff for you both, instead of one or the other of you either taking on the task for the whole family.

Wouldn’t it be nice to develop a relationship with a financial planner, a person whom you trust to have the skill and integrity to do well by you, and then know that they will take care of it all for you?

Hell, I’m a financial planner myself, and I’m already looking forward to my newly hired financial planner taking over investing our portfolio. Because that’s just one more piece of my brain I can free up for other things, including just sitting there, staring at the wall…but contentedly staring at the wall, not in some sort of anxious, paralytic panic.

So, yes, maybe you can do a perfectly good job managing your own investments. It is entirely reasonable to simply choose not to.

Reason #2: An investment professional can likely do better than you can.

What I don’t mean by this is that I can pick better stocks or mutual funds or ETFs than you can.

In a meaningful way, that part of investing has been commoditized. Whether you use a roboadvisor (ex., Betterment), invest it yourself at Vanguard or Schwab or Fidelity, work with a different financial planner, or work with me, you’ll likely end up with very similar funds. This simply reflects the broad acceptance that no one can beat the market, reliably, over a long period of time. The best bet is to “own the market” at low cost and then Don’t Touch It.

But my, there is So Much More to investing than just “security selection.” That’s the easy part! Thirty years ago, maybe it wasn’t: before ETFs existed, and most funds were actively managed and expensive. But nowadays, you have easy access to inexpensive, broadly diversified funds of all sorts.

I’ve seen a lot of ways in which we help our clients better manage their investments.

Remember the above assumption that “you have all the knowledge and self-awareness you need to manage your investments well”? Now we’re going to test that. I’m going to describe below many of the ways in which I (and many other financial planners) improve our clients’ investments.

Do any of these strike you as, “Oh, didn’t know about that. Wouldn’t have thought of that. Yep, I’ve been suffering from that for a while, and not doing anything to fix it.”? If so, then that is a good reason to hire a professional to manage your investments.

We make sure you’re invested in the right thing.

This is a big topic. It’s probably the most important category of investment work we do for our clients.

You might not know what you’re invested in. We make sure you do.

If you’ve been investing for a while in a 401(k), IRA, and a taxable investment account (or several), all while not really having a strong grasp on investing principles, you can easily default your way into a pretty interesting portfolio. (Yes, “interesting” as the universal euphemism for “f*cked up.”)

The most common “interesting” thing we see in new clients’ portfolios is that they are absolutely dominated by tech stocks, both individual tech company stock and tech-heavy funds.

Clients have never thought about the fact that they own few to no:

  • Small and medium size companies US companies
  • Companies outside the tech industry
  • Companies outside the US
  • Bonds

Sometimes, all it takes is pointing this out, and the client is all, “ooohhh…that’s probably not ideal, is it?” (And to be fair, sometimes I point it out, and the reaction is, “….and?”)

You might not know *why* you’re invested in what you’re invested in. We make sure you do.

I want to know why you own the investments you do.

Most of the time, the answer is the equivalent of shrugged shoulders. “…’Cause? I dunno.”

There are a lot of reasonable investment portfolios out there, even for the same person. But that doesn’t mean any portfolio can be reasonable for you. You gotta know why you’re investing in order to know whether a portfolio is right for you.

Once we figure out why you’re investing this money (your kid’s college in 17 years? retirement in 10? to buy a home in two?), then we can make a plan for investing that is targeted at those goals.

Maybe your existing investments are already doing that job. In which case, great, we don’t have to change much, if anything.

Maybe they’re not. In which case, not as great, but fixable!

In practice, this means we make a sell/keep/donate decision for each holding you already own. That way, each investment that remains in your portfolio is a deliberate part of your portfolio, not there because of inertia.

Make sure cash actually gets invested.

Having too much cash that should instead be invested is common.

Usually, you have a ton of cash in your bank account (or in your stock plan account, from selling RSUs) that you simply have no plan for and therefore…just sits there. And sometimes you did in fact move the cash into the investment account…but then don’t invest it.

You know what gives you a better chance of growing your money than letting it sit as cash? Investing it. Crazy, I know.

We regularly scan our clients accounts for extra cash that could be invested…and then pull it into their investment accounts and invest it.

We manage risk.

I’m using “risk” to mean the chance you won’t have enough money for your goals when your goals come due.

So, how do we manage risk? First, we start by identifying your goals and, importantly, how long you have until those goals start and how long they last. You want to buy a home in five years? We’re going to invest that money way differently than for your goal to retire in 20 years and live off of your portfolio for the ensuing 40 years.

We then choose a reasonable balance of:

  • stocks (high growth potential but high chance of losing money in any given year)
  • bonds (lower growth potential but also lower such chances)
  • cash (lowest growth potential but guaranteed to not lose dollar value)

in your portfolio. Say, 70% stocks/30% bonds/0% cash if you’re 10 years from a retirement that could last 40 years.

Okay, that’s the initial risk-management step.

The ongoing management usually involves “rebalancing” your portfolio. As your investments grow or fall in value, that 70%/30% can easily become 80%/20% or 60%/40%. Rebalancing means we’d buy and sell things to get it back to 70%/30%.

Rebalancing conveniently reinforces the investing best practice to “Buy Low, Sell High.”

We try to minimize taxes across your lifetime.

Our goal is not to try to minimize your taxes in any given year. It’s to minimize the taxes you pay over your lifetime. And yes, sometimes that can mean opting in to higher taxes this year to have even lower taxes in the future.

Here are some of the tactics we use to minimize your taxes:

  • Asset location: Putting certain investments with certain characteristics in certain types of accounts with complementary tax characteristics. (Learn more about asset allocation and how we implement it.)
  • Tax loss harvesting: When the stock market tanks (March 2020, anyone?) this can be an easy way to get a tax break for that year (and possibly for the next several). That said, we might choose to not tax loss harvest if we don’t think it’ll help lower your taxes over your lifetime, even if it helps now.
  • Tax gain harvesting: Sell at a gain in low-tax-rate years, and then immediately re-buy the investment. Now, admittedly, usually when people have low-tax years, we focus more on Roth conversions, or doing nothing in order to preserve eligibility for free or reduced-premium health insurance. But it’s a possibility we evaluate each year our clients have low-income/low-tax-rate years.
  • Replace tax-inefficient investments with more tax-efficient investments: Usually we find tax inefficiency in certain mutual funds, held in taxable accounts.
  • Identify and help you donate “appreciated securities” (investments that have grown) to charity. If you have investments in taxable accounts that have gained in value, it’ll probably save you taxes to donate those investments instead of cash.

We provide pretty pretty reports.

Reports can help you more easily understand what your portfolio looks like and how it’s performing.

We get the administrative work actually done, not perpetually hanging over your head.

The administrative side of managing your finances…well, I don’t need to tell you, it can really suck sometimes. So. Many. Lumbering. Bureaucracies.

It’s our job to help you get through them, sometimes even to get through them on your behalf.

We help you to:

  1. Open the necessary accounts
  2. Set up ongoing contributions to your accounts from your paychecks or bank accounts
  3. Roll your old 401(k) into your IRA. How many old 401(k)s you got out there, just..sittin’ there?
  4. Roll your IRA into your current 401(k) (to enable a backdoor Roth IRA contribution)
  5. Convert your IRA to a Roth IRA (aka, a Roth conversion)
  6. Make your annual IRA contribution. In the correct amount. To the correct IRA. And only when you’re eligible to do so. Including the ever-popular backdoor Roth IRA contribution.
  7. Change investment selections in your accounts that we don’t manage for you but that we advise on, notably, 401(k)s and HSA.
  8. Change beneficiaries on all your accounts, when necessary.
  9. Move your taxable investment account into your trust (i.e., “fund” your trust).

We help you behave in a productive way vis-a-vis your investments.

Pretty much all industry surveys say that clients don’t hire financial planners for behavioral or emotional coaching.

At the same time, we financial planners are all “It’s a super valuable thing we do for our clients!”

So, I mention it here…hesitantly.

In a nutshell, when an investment (stock, fund, etc.) is going up up up, all of us humans naturally think that it’ll simply continue to go up up up. So, hodl! And maybe even buy more?

The role of the financial planner is to say yes, it certainly is tempting, isn’t it? Whoo! That stock, it’s on a tear! Now, let’s revisit your Investment Policy Statement, which tells us why we’re investing and how we’re investing to achieve that goal. Are these changes you’re proposing consistent with that plan? If not, tell me more about why would you want to vary from that plan? If yes, sure, let’s discuss further.

And we’ll do the same thing the next time your portfolio drops a bunch in value, or your company stock, which you own tons of, goes down in value.

It’s not that we planners are special human beings devoid of emotion. It’s that we (ideally) have been trained to have processes that take us out of our emotional brains and into our rational ones when managing investments.

We do all of this, over and over.

There is great value in doing all of this work once, to set up a good investment portfolio.

There is at least as much value in revisiting this regularly, to ensure than the plan is still the right one, and the investments are still serving the plan.

Financial planners (should) have a process for this. At Flow, we incorporate an investment review in each Annual Renewal Meeting. Nothing should ever get too far off track without us noticing it.

So, girls and boys, that is why you might want to have a professional manage your investments.

Do you want someone to do all this for you…and your investments? Reach out and schedule a free consultation or send us an email.

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Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

Use Asset Location to Pay Less in Taxes and Get More Money out of Your Investment Portfolio

Block Woman surveys scattered piles of coins placed on a grid of squares

What if you didn’t have to save more than you already are, if you didn’t have to change what you invested in…and you could still get more money out of your investment portfolio? Pretty nice, eh? Well, you can.

May I introduce asset location.

Asset location is an investment strategy that puts certain types of investments into certain types of accounts based on the investment’s tax characteristics and the account’ tax treatment. The goal is to create larger after-tax returns for your investments. “After-tax” is the money you can actually spend. Pre-tax numbers are simpler to understand…but not as useful.

Vanguard estimates that proper asset location can increase after-tax return by 0..05 to 0.3% each year. Sounds…kinda small. But if you compound that over years, and talk about it in dollars and not percentages, it can sound…kinda big.

In this post, I’ll describe a lot of the nitty gritty of asset location, and I’ll end with how we use it here at Flow for our clients’ investment portfolios.

This Is the Icing, Not the Cake.

You do not need asset location to be a successful investor. It is icing on the investment cake. That cake’s ingredients?

  • Broad diversification. Owning not 1 stock or 10 stocks, but 1000 stocks.
  • Low cost
  • An appropriate “asset allocation” for the amount of time until you need the money. That is, the balance of stocks and bonds in your portfolio. Yes, we’re talking asset ALLOcation vs. asset LOcation. Sorry about that! I don’t pick the names!

(You can learn more about our beliefs about what constitutes good investing, in this blog post.)

To boot, the younger you are and the smaller your investment portfolio, how much you save is usually more important than all those things. 

But if you’ve already got the cake, and you’ve got the personal wherewithal to ice the cake, or if you’re working with a financial planner whom you’re paying to ice the cake, then yeah, let’s do this thing.

The Rules of Asset Location

Here are the rules that govern asset location:

Rules based on tax-efficiency:

  • Put your tax-efficient investments in your taxable accounts.
    For example, a total US stock market index fund. “Tax efficient” means your investment doesn’t produce much investment income (interest, dividends, capital gains distributions) during the year.

  • Put your tax-inefficient investments in an IRA or 401(k) (or other tax-protected account).
    For example, a taxable-bond fund.

Rules based on growth potential:

  • Put low-growth investments in a traditional IRA or traditional 401(k) (or other pre-tax account).
    For example, a total US bond-market fund.

  • Put high-growth investments in a Roth IRA, Roth 401(k) or HSAs (or other after-tax or tax-free account).
    For example, an S&P 500 fund.

One more rule that doesn’t fit neatly above: Put international-stock funds in taxable accounts. These funds typically pay foreign taxes, and if you hold them in taxable accounts, you can get a foreign-tax credit for those taxes paid, reducing your US taxes. If you hold them in a tax-protected account, you can’t get that credit.

Put ‘em together and what have you got?

Bippidi boppidi…oh wait, no.

You get a decision matrix like this:

Why Does Tax Efficiency Matter?

If you were retired, it’s possible that having investments producing income throughout the year wouldn’t be a bad thing. You’ll need money to live on, after all! You can use that investment income (interest, dividends, fund distributions) as that income.

But if you’re still working, your job provides all the income you need (god willing). You don’t want to have to pay taxes on income you don’t need. So, we want to minimize taxable income coming from your investments.

Which means we put tax-efficient investments in an account where you do pay taxes, because those investments won’t create much taxable income. And we put tax-inefficient investments in accounts that are tax protected, because regardless of how much income your investments create, you don’t owe taxes on it.

Why Does Growth Potential Matter?

Because we want to minimize the bucket that the government can take taxes out of and maximize the bucket that you own 100% yourself.

Let’s say you retire and have a $1M portfolio. The after-tax size of your portfolio varies depending on how much of your portfolio is in a pre-tax IRA vs. a Roth IRA. The bigger your Roth IRA is relative to your pre-tax IRA (for the exact same total portfolio balance!), the more money you will have to spend.

In this chart, you can see that when the $1M is split evenly between a Roth IRA and a traditional IRA, your after-tax portfolio is worth “only” $840k. (We’re assuming a marginal (i.e., top) tax rate of 32%.)

But let’s say you used asset location over many years, putting your high-growth investments in a Roth IRA and your low-growth investments in a pre-tax IRA. As a result, your Roth IRA is worth $600k, and your traditional IRA $400k. In this scenario, your after-tax portfolio would be worth $872k. Same $1M total portfolio…but a bigger Roth bucket gives you more money to spend.

Follow these rules gently, not obsessively.

These are guidelines. You can get a lot of the benefit of asset location by adhering only loosely to these rules.

You don’t have to put all your stock holdings in a Roth or even taxable account. It’s okay to have some in a pre-tax IRA! Just get a good chunk of your stock holdings (especially if they’re tax inefficient) in your Roth IRA to increase your lifelong tax savings.

Balance Optimization (Icing) with Simplicity

Asset location is easy enough to do, at a high level.

The more narrowly defined your investments, the more exacting you can get in your asset location…but at the cost of portfolio simplicity. So, I’m not sure you should get that exacting.

For example, a high-level implementation of asset location would mean getting most of your stock investments into a Roth IRA and most of your taxable bond investments into a traditional IRA.

In contrast, let’s say you break your portfolio down into individual stocks, commodities, micro cap US stock funds, small cap, mid cap, large cap, both growth and value, equivalent complexity on the international front, private-company stock, cryptocurrencies, etc. You now can pick the best account for each of those 10+ types of investments to go into. That’s harder to set up in the first place and harder to maintain.

I recommend getting most of the value of asset location with the least amount of setup and maintenance required. Asset location is optimization enough unto itself. I don’t believe you need to optimize the optimization.

The Challenges of Asset Location

An asset-location strategy is a multi-year (-decade) commitment. As with pretty much any investment strategy, there are challenges that you should really think about before you commit to it.

Each Account Will Perform Differently.

I used to work at a financial advisory firm that did not use asset location. They invested all of a client’s multiple accounts the same.

If the client’s target asset allocation was 90% stocks/10% bonds, then by gum, their taxable account was 90% stocks/10% bonds, their pre-tax IRA was 90% stock/10% bonds, their Roth IRA was 90% stocks/10% bonds…and all the spouse’s accounts were also 90% stocks/10% bonds.

I asked the lead advisor one day why they didn’t use asset location. He explained (I paraphrase) that a lot of clients couldn’t handle the fact that each account would perform differently than the others, and that their spouse’s accounts would also perform differently than theirs.

Your all-bond pre-tax IRA would grow 3% in a year, and your spouse’s stock-heavy taxable account would grow 16% in one year. Or one loses 3% while the other loses 20%. That doesn’t feel good.

Asset location is a portfolio-level strategy, not an account-level strategy. That means you have to be prepared for each individual account to perform differently. Your focus should be on The Total Portfolio. How did all your accounts perform together?

Big Money Movements In and Out of an Account Can Create a Challenge.

Let me tell you a story about difficulties we ran into when implementing asset location in a client’s portfolio.

We were managing this client’s Financial Independence (aka Retirement) portfolio, which consisted of a taxable account, a traditional IRA, and a Roth IRA. The portfolio’s asset allocation was 85% stocks/15% bonds. As prescribed by the basic asset location rules, all her bonds were in the traditional IRA.

Then we helped her roll that traditional IRA money into her 401(k) so that we could do a backdoor Roth IRA for her. Now, with her IRA emptied out, her asset allocation was…100% stocks. Eeek.

We needed more bonds. How to get them? We had two types of accounts to put them in: her Roth IRA and her taxable account.

I didn’t want to put them in her tax-free Roth IRA, as that’s the account where I want to put our “growthiest” possible investments.

That left her taxable account. But in order to buy more bonds, I’d have to sell some of the existing stocks, creating a taxable gain. She’s mid-career as a director at a big tech company. She’s earning a bunch of money, at a very high tax bracket. I really don’t want to create capital gains taxes if possible.

In her case, thankfully and coincidentally, around the same time, she received a gift from a family member of a bunch of a single stock. Whenever a client has a concentration in stock like that, we create a diversification strategy. In this case, part of that strategy was to use the sales proceeds to buy bonds.

You can perhaps see how, if she didn’t have the luck of that big gift, we likely would have ended up doing something “suboptimal” in either her taxable account or her Roth IRA in order to achieve the more important target of getting bonds back into her portfolio (i.e., getting her asset allocation back on target).

This same thing can happen when you do a big Roth conversion. Before the conversion, you have all sorts of pre-tax money, and you can hold bonds there. After the conversion, you have less pre-tax money and more Roth money. How will you make sure that the portfolio’s asset allocation is still on target?

It Makes Your Investments More Complex.

One benefit to investing all your accounts the same way is that, if you put more money into an account or take money out of an account, it’s easy to figure out how that account should be invested with its new (higher or lower) balance: The exact same as it was before. Was it 90% stocks/10% bonds before? It still is.

If you use asset location, every time you add a lot of money to or take it out of an account, or every time you do your annual “rebalancing” of your portfolio, you have to figure out how to change the asset allocation in each account to ensure that the total portfolio’s asset allocation is still correct (remember, the asset allocation is more important!), while still obeying the basic rules of asset location.

Tax Laws Can Change, Undercutting the Value of Asset Location.

The value of asset location comes from the fact that you have to pay taxes on investment income and withdrawals from pre-tax accounts. The higher the taxes, the bigger the value of asset location.

As tax law changes, asset location could become less valuable. (Of course, it could go the other way, too.) Certainly, if tax rates fall, asset location becomes less valuable. Already, the value of putting real estate investment trusts (REITs) in tax-protected accounts (IRAs, 401(k)s, HSA) isn’t as great as it used to be, because now you can get some tax benefits by holding real estate in a taxable account.

What We Do at Flow

At Flow, in our clients’ portfolios, we follow the good ol’ 80/20 rule: we want to get 80% of the benefits of asset location with 20% of the work (and complexity).

Here’s our focus:

  • Roth IRAs and HSAs get stock funds.
  • Pre-tax IRAs get taxable-bond funds.
  • Taxable accounts get everything else.
    • If we need more bonds in the client’s portfolio, we’ll often use tax-free (aka, muni) bond funds in the taxable account.
    • We use broad market index funds, so all our stock funds are tax efficient, whether they’re here in the taxable account or in the tax-protected Roth.

This strikes me as a good balance of simplicity and tax optimization. Other advisors with good investment philosophies and implementations do it differently. As I’m fond of quoting:

“There is no perfect portfolio. There are many perfectly fine portfolios.”

Do you want your investments managed in a way that balances optimization with your ability to understand what’s going on? Reach out and schedule a free consultation or send us an email.

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Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.

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