|The traditional approach says to hold bonds in a tax-deferred account and stocks in a taxable account. The rationale is that you're better off deferring taxes on securities, such as bonds, that generate a lot of taxable income.
Newer research is drawing somewhat different conclusions. It says that, in many cases, you should own stocks in tax-deferred accounts and bonds in taxable accounts, especially if you're investing for 15 years or longer.
Why? Because if you're investing long enough, the higher total returns of stocks over time can generate a greater tax burden than the income of bonds over the same time.
Let's look at an example from T. Rowe Price Associates. Investor A and Investor B each decide to place $10,000 in a bond fund and $10,000 in a growth-stock fund. Investor A keeps her bond fund in a taxable account and her growth-stock fund in a tax-deferred account. Investor B does just the opposite, placing the bond fund in the tax-deferred account and the growth-stock fund in the taxable account.
Assuming an ordinary income rate of 28%, a capital-gains rate of 20%, and liquidation of both accounts after 20 years, Investor A, who put the stock fund in the tax-deferred account, ended up with the best aftertax results--$197,700 over the period studied versus $184,500 for Investor B. This pattern held up for higher tax rates (31% and 36%), too. Only when the time period was less than 10 years did the pattern break down.
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