How To Create a Tax Efficient Investment Portfolio with Asset Allocation

How to Create a Tax Efficient Portfolio | www.TheHeavyPurse.comI covered a lot of information last week in how to understand your tax reality and hope you were able to digest it all. My goal with every post I write is to deliver immense value, but I also don’t want to overwhelm you! Instead, I want to empower you to make good decisions around taxes. Therefore, I’m going to keep my ongoing posts on taxes a bit shorter and more succinct. Today, I’m going to discuss investment tax strategies, specifically asset allocation and harvesting losses.

The #1 Investment Tax Mistake

My first rule is you MUST know what you own and why. I have said this repeatedly, but this is one of the greatest mistakes people make with their investments. They don’t know what they own or why AND don’t understand how it is taxed. A solid investment strategy takes all three into consideration because picking whichever investment has the best return is not an investment strategy.

Disclosure: These strategies will not all be relevant to your personal situation and should be discussed with your CPA and financial advisor prior to implementation.

The Phantom Tax Impact on Investments

We discussed phantom tax last week but to quickly recap — phantom income is the taxable income from a mutural fund or other investments that you have not sold. A high performing fund manager is concerned with getting the highest returns. They are not concerned about the tax impact to you or your tax bracket. This is especially frustrating for investors during a bear or down market. Can you imagine a big tax bill the same year that your account lost money? Trust me, it happens!

How Asset Allocation Can Help Build a Tax Efficient Portfolio

Let’s take a closer look at how we can build a tax efficient portfolio through asset allocation.

What is Asset Allocation?

We’ve all heard the phrase “don’t put all your eggs in one basket” and that is what asset allocation is at its most basic form. It is the apportioning of investment funds across the categories of assets. This includes cash equivalents, stock, fixed income investments and tangible assets, including real estate, precious metals and collectibles. It also applies to sub-categories in bonds and stocks. Asset allocation affects both risk and returns and is a deliberate and thoughtful approach to selecting investments based on your risk tolerance, timeframe, goals and tax liability. It is not randomly selecting different investments.

Utilize Non-Qualified and Qualified Investments to Your Advantage

When it comes to taxes, there are Qualified Investments (tax-deferred) and Non-Qualified Investments (currently taxable). It is the Non-Qualified Investments that surprise investors with phantom income for current taxation. This why it is so important to know what you own. When you understand how your investments are taxed, you can then build a strategy around them to your advantage. Let me show you one possible strategy.

A Hypothetical Retirement Portfolio

This is a hypothetical investment portfolio for a married couple.

The mistake I regularly see many make is they used their non-qualified investment accounts for their higher performing investments and end up with an unexpected tax bill. This happens when you look at each investment as separate. Many couples forget to look at all of their 401k’s and IRA’s together. You should consider all the money for retirement as one portfolio. I would encourage you to consider using high-performing or non-tax-efficient investments in your Qualified Plans, then balance the allocation in your Non Qualified Plan to build a tax efficient portfolio.

Please Note: When building your portfolio for retirement, you need to consider your desired timeframe and risk tolerance as you select investments and create your asset allocation. Do not just consider taxes.

For the cash, you can consider tax-free investment, such as municipal bonds. But do the MATH first. Depending on your tax bracket, it may make more sense to pay the taxes and possibly yield a higher return in another investment.

The Bottom Line: Understand your allocation as it relates to the potential current taxation of your accounts.

Shannon’s Tax Break Tip

Keep in mind that paying taxes is not always a bad thing. I have seen many investors make decisions that were not in their best interest, just to avoid a fee or taxes. Do not make a knee-jerk reaction because you dislike paying taxes. If you know your investments and goals, you can do the math and make an informed decision.

How To Harvest Tax Losses/Gains

There is nothing investors dread more than seeing loss in their portfolio, even though we all should (hopefully) be prepared to handle market volatility. Still, it can be gut-wrenching, which can lead to emotional decisions that do more harm than good. Trust me, I understand. I don’t like seeing loss in my investment portfolio either. But there is a silver lining too. I have taught myself (and my clients) to ask themselves, “How can I take advantage of this?” which places you in a position of power and control, rather than panic.

Again, in order to get to that place, you must understand your portfolio and investments. There are so many mutual funds, ETF and stock choices available. If you have a loss in one asset class, many times you can sell to solidify the loss, then re-buy a similar (but not equivalent) asset. By doing this, you may be able to create Long Term Capital losses that you can carry forward to the years where you have capital gains. In good years, you can use these losses to offset those gains. This is called tax harvesting and is one reason I like pull backs in the markets.

DISCLOSURE: You should work with your financial advisor to understand the advantages and rules around harvesting loss, including the Thirty Day Wash Rule. Your financial advisor and CPA can help you build an appropriate strategy on how to take advantage of loss in your portfolio based on your personal situation.

Up Next: Retirement Plans

Next Monday, I’ll take a look at retirement plans at work and for the small business owner.


The Heavy Purse Store is now open! My new downloadable Money Club Workbooks are now on sale. Each workbook provides five targeted lessons to help you raise Financially Confident Kids. Please check them out in The Heavy Purse Store.

February 23, 2015  •  20 Comments  •  Taxes

Leave a Comment


  1. Monday, February 23rd, 2015
    I've noticed that people seem to use their non-qualified accounts for their higher performing investments. I never understood that. Higher performance generally means higher risk and higher risk is historically better in a long term situation, like a tax-sheltered account. I've always thought it was weird that people often do it the opposite way.
    • Shannon Ryan
      Sunday, March 1st, 2015
      The one thing I have learned is that many people know the "rules" of investing, but still do the exact opposite. Often times out of an emotional response.
  2. Monday, February 23rd, 2015
    Great post Shannon!! I often talk to my clients about looking at their asset allocation over all of their accounts and allocating the assets based on the type of account and expected performance. I also think that people don't think enough about how to maximize the tax situations that happen within their taxable accounts. Gains and losses can be strategic if you manage it properly.
    • Shannon Ryan
      Sunday, March 1st, 2015
      People get caught up in celebrating gains without understanding their tax implication and creating any type of strategy around them. We may not like losses in general, but they can actually be quite advantageous too, but it does require careful planning, rather than the emotional reaction of simply cutting losses. Loss will always happen and people need to ask themselves how they can use it to their advantage.
  3. Monday, February 23rd, 2015
    Shannon, love what you said about asking yourself "How can I take advantage of this?" when it comes to portfolio losses. I'll never forget the story I read about a father and husband who, during the Great Depression, went out and bought other people's farm and other equipment that they had no choice to sell for pennies on the dollar. Him viewing trouble in the market as an opportunity made him a wealthy man when he later sold that merchandise for a profit.
    • Shannon Ryan
      Sunday, March 1st, 2015
      Thanks, Laurie! I certainly understand how seeing loss in a portfolio can lead to emotional responses but too often our response isn't in our best interest in the long wrong. But if we can train ourselves to take a deep breath and look at it from every angle - we may find a way we can use it to our advantage. The story you shared is spot-on. A lot of people fled the markets during our most recent recession but the smart investors were buying low.
  4. Monday, February 23rd, 2015
    Excellent post Shannon! I spoke with people all the time who would have their high performers in a non-qualified account and would either be surprised or upset once tax time came around. I know it takes work, but it's so vitally important to stay on top of to avoid being surprised. That said, I could not agree more about taking advantage - you just have to look at investing that way on certain occasions. If a down day means I can harvest some losses then that can definitely be a good thing given the right circumstance.
    • Shannon Ryan
      Sunday, March 1st, 2015
      Thanks, John! It's an unfortunate reality but a lot of people don't understand how qualified and non-qualified really differentiate from one another or what investments may be better suited for each one. No one likes tax surprises, which is why it's so important we stay on top of it. Harvesting loss, when done right, can absolutely put a smile back your face when tax season rolls around.
  5. Monday, February 23rd, 2015
    I have most of my investments in qualified accounts so this issue doesn't really come up. I guess once we max out our qualified plans then this will be more of an issue...although if we able to max out our qualified accounts, it would be a good problem to have.
    • Shannon Ryan
      Sunday, March 1st, 2015
      It would be a good problem to have, Andrew!
  6. Tara
    Monday, February 23rd, 2015
    A common misstep I often see higher income people make is going for tax free/advantaged investments and not realize they get added back in for Alternative Minimum Tax (AMT). In the long run they aren't as profitable as expected. And often people don't even realize because they don't understand their taxes enough to calculate how much of their taxes were paid because of a given investment return. Also, a lower income person investing in tax advantaged investments, as you mentioned, typically have a better net return with the taxable investments. Sometimes people try to get too tricky about saving taxes. I like to remind people, if you're paying taxes that means you made money. Appreciate that you're ahead, even after paying taxes.
    • Shannon Ryan
      Sunday, March 1st, 2015
      Taxes are a complicated matter, which is why it's so important people stop thinking of taxes in regards to filing them annually but become strategic so they understand how they affect their personal situation and can make informed choices. And I absolutely agree - we have to remember that paying taxes is not the worst thing in the world. It's certainly a sign that we made money and hopefully more money than the previous year.
  7. Monday, February 23rd, 2015
    The vast majority of our investments are in qualified accounts or real estate, but we've just begin putting more in non-qualified accounts to have some diversity and money to use before traditional retirement age if we need that. I need to learn much more about tax harvesting as we go forward.
    • Shannon Ryan
      Sunday, March 1st, 2015
      I know you're a big fan of real estate, Kim, and becoming quite the real estate magnate in your hometown! :) And yes, you don't want to be caught in situation where you get penalized for taking money early because you want to retire on your timeframe, not the theirs.
  8. Monday, February 23rd, 2015
    Great post, Shannon! I've personally had a lot of fun learning about asset allocation and picking what to invest my 401k and HSA in. I finally ventured into individual stocks, too, and one thing I always force myself to do is to ask "why?" Why do I own these stocks/funds? What is my purpose in allocating 20% to this and 30% to that? If you can answer those questions you are leagues ahead of the average Joe.
    • Shannon Ryan
      Sunday, March 1st, 2015
      Thanks, DC! It is a lot of fun to learn about investments and individual stocks. Admittedly, not everyone feels that way, but it is important to understand the "why" behind our investment choices. And sadly for too many of us it simply boils down to return, which isn't enough. And yes, if can answer the "why", you are definitely ahead of the average investor.
  9. Tuesday, February 24th, 2015
    I always think- if I have to pay taxes on it, that means I made more money, which is a good thing!
    • Shannon Ryan
      Sunday, March 1st, 2015
      You got it, Stefanie!
  10. Wednesday, March 11th, 2015
    I love your point about considering the tax repercussions of investments. We've chosen to invest for our kids in taxed UTMAs and I was surprised when they did well this year and we got more tax than usual. It shouldn't have caught me off guard, but it did. I promise to consider that aspect of future investment!
    • Shannon Ryan
      Thursday, March 12th, 2015
      Thanks, Janeen! When it comes to investing, people tend to only focus on growth and not about taxes, but it is something that you needs to be considered and planned for.
  • Meet Shannon

    "As a Certified Financial Planner, it is my passion to help individuals and families build a healthy relationship with money. I look forward to helping you raise financially confident kids.” - Shannon Ryan