Asset location in tax-deferred and conventional savings accounts

This paper derives optimal asset allocations (which assets to hold) and asset locations (in which accounts to hold them) for a risk-averse investor saving for retirement. The investor can hold taxable corporate bonds, tax-exempt municipal bonds, and stocks either in a tax-deferred or a conventional taxable savings account. Taxable bonds have a preferred location in the taxdeferred account and tax-exempt bonds have a preferred location in the taxable account for investors in sufficiently high tax brackets. Tax-efficient stock portfolios (e.g. passively-managed mutual funds) should be held in the taxable account and tax-inefficient stock portfolios (e.g. actively-managed mutual funds) should be held in the tax-deferred account. We show that locating assets optimally can significantly improve the risk-adjusted performance of retirement saving. D 2002 Elsevier B.V. All rights reserved. JEL classification: G11; G23; H24