Asset allocation decisions are quite a bit more complex when you have a sizable amount of money in taxable accounts versus having almost your entire retirement portfolio invested in tax deferred accounts (401K’s IRA’s etc.). The reason is two-fold.
First, the placement of your various asset classes across your accounts is much more important when one or more taxable accounts are involved since the gains (or losses) generated have different tax treatments (interest income, dividend income, capital gains etc.). In tax deferred accounts all gains will eventually be taxed as ordinary income no matter what form the gain was initially realized.
The basic strategy in terms of placement of your asset classes is as follows: Place asset classes that generate ordinary income (bonds, real estate etc.) in your tax deferred accounts. In most instances ordinary income will have the highest marginal tax rate so it will beneficial to defer that income as long as possible. Asset classes that generate growth largely from capital gains (i.e. growth stocks) should be placed in your taxable accounts. In taxable accounts, Exchange Traded Funds (ETF’s) are a better choice than traditional mutual funds since capital gains are not passed through annually. Recognition of capital gains on ETF’s will be deferred until you actually sell the ETF (same as an individual stock). If you follow the buy and hold approach that I recommend you may still be holding some of those ETF’s well into the future when they can be donated or passed on as part of your estate, escaping capital gains tax altogether.
Once you have filled up either your taxable or tax deferred accounts with the most favorable asset classes, place the remaining asset classes (i.e dividend paying stocks) where there is room. There are other nuances to be considered but this gives you a general idea of the approach.
The second issue that adds complexity related to taxable accounts has to do with rebalancing the portfolio. Unlike tax deferred accounts where you can generally get away with rebalancing the portfolio once a year (absent a major market correction), taxable accounts need to be monitored much more closely. The opportunity exists in taxable accounts for what is called tax loss harvesting. If a fund drops in value you can sell the fund locking in a capital loss that can offset capital gains in the current year. Then you can purchase a similar fund (or the same fund after 31 days) to get back to your desired asset allocation. To make the most use of this technique you need to do some tax planning to understand your current and future tax rates as well as expected capital gains that need to be offset.
If you have a sizable taxable account (or accounts) it will likely be worthwhile hiring a financial advisor to manage your money on an ongoing basis who is knowledgeable about these tax issues. This differs from those who only have tax deferred accounts. In that case, the most cost effective approach will generally be to maintain your own retirement accounts and hire an advisor on an hourly or flat fee basis to help with the annual asset allocation and rebalancing.