Asset allocation and asset location : household evidence from the survey of consumer finances

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ASSET

ALLOCATION

AND

ASSET

LOCATION:

HOUSEHOLD

EVIDENCE

FROM

THE

SURVEY

OF

CONSUMER

FINANCES

Daniel

Bergstresser

James

Poterba

Working

Paper

02-34

September

2002

Room

E52-251

50

Memorial

Drive

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MA

02142

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MASSACHUSETTS

INSTITUTE OF

TECHNOLOGY

ASSET

ALLOCATION

AND

ASSET

LOCATION:

HOUSEHOLD

EVIDENCE

FROM

THE

SURVEY OF

CONSUMER

FINANCES

DanielBergstresser Harvard Business School

James

Poterba

MIT

and

NBER

March

2001 Revised

September

2002

ABSTRACT

The

rapidgrowth ofassetsinself-directedtax-deferredretirementaccounts has generateda

new

setof

financialdecisionsfor

many

households. Inadditiontodeciding

which

assets tohold,households with

substantial assets inbothtaxable

and

tax-deferredaccounts

must

decide

where

tohold them. Thispaper

uses data

from

the Surveyof

Consumer

Financestoassess

how

many

householdshave

enough

assets in

bothtaxable

and

tax-deferredaccountstofacesignificantassetlocation choices. Italso investigates the

assetlocationdecisions thesehouseholdsmake. In 1998,45 percentof households

had

at least

some

assets ina tax-deferred account,and

more

thantenmillionhouseholds

had

atleast$25,000inbotha

taxable

and

a tax-deferred account.

Many

householdsholdequities in theirtax-deferredaccounts,but not

intheirtaxableaccounts,whilealsoholdingtaxable

bonds

in theirtaxable accounts.

Most

ofthese

households could reducetheirtaxes

by

relocatingheavily-taxed fixed

income

assets to theirtax-deferred account. Assetallocationinside

and

outside tax-deferred accountsisquite similar,with about seventy percentofassetsineachlocationinvestedinequitysecurities. Fornearly three quartersofthehouseholds

thatholdapparently tax-inefficientportfolios, ashiftoflessthan$10,000in financial assetscan

move

theirportfolio toatax-efficient allocation. Assetlocationdecisionswithin

IRAs

appeartobesensitive to

marginaltax rates;

we

do

not findevidenceforsuch sensitivity inother tax-deferred accounts.

We

aregrateful to

Brad

Barber,

David

Bradford, JoelDickson,

Roger

Gordon,

Andrew

Samwick, and

John

Shoven

forhelpfulconversations,to

Amir

Sufi forassistancewiththe Surveyof

Consumer

Finances,andtothe

Hoover

Institution,theNationalInstituteof Aging,

and

theNationalScience Foundationforresearch support.

Households

have always facedtheassetallocationproblem,havingtodecide

which

assetsto

purchase

and

how much

toinvest ineach of them.

But

withtherecent

growth

ofself-directed retirement

planassets,

many

households

now

alsofaceanasset locationproblem. This isthequestionof

how much

of

agivenassettoholdinataxableaccount,

and

how much

ofittoholdina tax-deferredaccount. Assets

inparticipant-directedtax-deferredaccountstotalednearlyfivetrilliondollars atthe

end

of 2001, with

$2.4trillioninIndividualRetirementAccounts,

and

$2.3 trillionin401(k)-typeplans.

At

the

end

of

1990,

by

comparison,there

were $637

billion in

IRAs,

and $735

billion indefinedcontributionplans.

The

recent

growth

of IRAs,401(k)'s,

and

other self-directed tax-deferred retirement vehicles has

drawn

substantial interesttotheinvestmentdecisions

made

by

households withthese accounts. Asset

locationhas

begun

to attractattention

from

researchers inpublicfinance

and

financial economics,

and

it

isafrequent topicofdiscussion

among

financialplanners.

Shoven

(1998)outlined the structureofthe

asset locationproblem,

and

observedthattaxminimization

would

usuallydictateholdingheavily-taxed

taxable

bonds

inthetax-deferredaccount,withless-heavilytaxedequitiesinthetaxable account.

Recent

work

by

Dammon,

Spatt,

and

Zhang

(2002),

Huang

(2001), Poterba, Shoven,

and

Sialm(2001),

and

Shoven and

Sialm (forthcoming) hasoffered further insight

on

theoptimalasset

mix

forhouseholds

facingvarioustax

and

financialcircumstances.

Absent

liquidityor other considerations,households should holdrelativelyheavily taxedassets in

theirtax-deferredaccount.

Whether

thisimpliesthattaxable

bonds

should be heldinthetax-deferred

account

depends

on

thesetofassetsavailabletothehousehold. For example,

Shoven and

Sialm

(forthcoming) considerthe assetlocationdecisionfor investors

who

can only holdequitiesinthe

form

of

relativelytaxinefficientvehicles,suchashigh-turnoveractively-managedmutualfunds. Ifthese

investorshave accesstotax-exempt bonds, thentheiroptimal assetlocation

may

involve equitymutual

fundsinthe tax-deferred account,

and

tax-exempt

bonds

inthetaxableaccount.

Most

oftherecentresearch

on

assetlocationhas focused

on

the derivationof tax-minimizing

portfoliostrategies,ratherthan

on

theanalysisof

household

portfoliochoices.

Three

studies have

(1997),is based

on

asurvey

of

TIAA-CREF

participants. It findsthat investorschoosesimilar asset

allocationsintheirtaxable

and

tax-deferredaccounts,with littleapparent regardforthebenefits of

tax-efficientassetlocation.

One

open

issue concerningthisresearchconcernsthe extentto

which

the

behavior of

TIAA-CREF

participantscan begeneralizedtothepopulationatlarge.

A

second

study,Barber

and

Odean

(forthcoming), isbased

on

data

drawn from

brokerage firm

records.

The

datasuggestthathouseholds holdequitymutual funds

and

taxable

bonds

intheir

tax-deferred accounts,while theyholdindividual equitiesin theirtaxableaccount.

Because

individual equity

holdings tendtobelessheavily taxed than

bonds

orequity

mutual

funds,this assetlocation patternis

broadlyconsistentwith tax-minimizingbehavior.

However,

householdsare

more

likelytotrade stocks in

theirtaxablethanin theirtax-deferredaccount,

even

thoughtradingin the tax-deferredaccount

would

not

generate currentcapitalgains taxliability.

A

key

concern withthisstudyisthedegreeto

which

data

on

assetsheldthrougha singlebrokerage firmdepict ahousehold's broader balancesheet,

and

inparticular

whether

households

may

have

offsettingpositionsatother financialinstitutions.

Finally,athirdstudy,

Amromin

(2002),usesdata

from

the

Survey of

Consumer

Financesto

investigate

whether

precautionary

demands

forfinancial assets,coupled withpenalties

and

restrictions

on

withdrawing

assets

from

tax-deferred accounts, canexplain deviations

from

tax-efficientassetlocation

patterns.

The

paperalsoprovides

summary

information

on

tax-deferredaccountholdings.

The

findings

suggestthatthe standard deviation

of household

labor

income

isrelatedtoassetlocation choices,with

householdsin lessriskyoccupationschoosing

more

tax-efficientasset locations. Thispaperrepresentsan

importantstep

toward

building

models of

the factorsthataffectassetlocation choices.

In thispaper,

we

also usedata

from

severalSurveys

of

Consumer

Finances

(SCFs)

toanalyze

assetlocation decisions.

The

SCF

dataprovide complete

and

disaggregatedata

on

the portfoliosheld

by

a

large

sample

of households.

The

SCF

askshouseholdstoaggregatetheirholdingsacrossallfinancial

intermediaries. This

makes

itpossibletostudythe overall structureofthe householdportfolio,ratherthan

Thispaper has

two

goals.

The

firstis todescribe theimportance ofthe assetlocationproblem,as

measured

by

the

number

ofhouseholdsfacing asset location decisions

and

thevalue ofthe assetsheld

by

households with suchchoices.

The

second istoexplore assetlocationpatterns,

and

to relatethese

patternstohouseholdcharacteristicsthataffectthe gains

from

tax-efficientasset location,particularly

household marginaltaxrates.

The

paperisdividedintofive sections.

The

firstpresents information

on

the

number

of

householdsthatface substantivelyimportantassetlocation decisions.

We

identifysuchhouseholds

by

the

presenceofsignificantassetholdingsinbothtaxable

and

tax-deferredaccounts

(TDAs).

Section

two

explores

how

householdsallocatetheirassetsintaxable

and

intax-deferred accounts. Inthe aggregate,

equityinvestments

make

up

more

thantwo-thirdsoftax -deferred financial assets

and

a similarproportion

oftaxable financialassets.

The

thirdsectionfocuses

on

assetlocation decisions. Itdevelopsa simple

classificationrule toindicate

whether

ornothouseholdsare

making

assetlocation decisionsthatare tax

efficient.

We

developseveralpossible

measures

oftax efficiency,

and

we

present estimatesofthe

portfolioreallocationthat

would

be

needed

tobringhouseholdsintax-inefficientpositionsto tax-efficient

points. Sectionfour presents cross-sectional regression

and

discretechoiceevidence

on

the correlation

between

various

household

characteristics

and

assetlocationpatterns.

We

investigate age,income,

and

net

worth

patternsintax efficiency,

and

study

how

ahousehold'smarginal

income

taxrateaffectsthe

likelihoodthatitsassetlocationchoicesaretax-efficient.

A

briefconclusion suggestsdirections for

futureresearch.

jL

How

Many

Households Face

AssetLocationChoices?

The

recentexpansion oftax-deferredaccountshas includedIndividualRetirement

Accounts

(IRAs),

which

are availabletoalltaxpayerswith earned income, 401(k)plans,

which

are

employer-provided definedcontributionplansavailableat

some

firms,403(b)plans,

which

aresimilarto401(k)

plansbutare availableto

employees

atnonprofitinstitutions,

and

a

number

ofothersmallerprograms.

characteristicsofthose

who

participateinthem. Table1

shows

thetotalvalueofassetsheldintax-deferred

accountsasafractionoftotalfinancialassets forselected yearsduringthelast

two

decades.

The

TDA

share

was

16.8percentatthe

end

of 2001, almost doublethesharein1985. Tax-deferredassetsareroughlyequally

divided

between

IRAs

andvarious typesofdefined contributionpension planaccounts.

A

growing

fraction

oftheassets in

IRAs

were

actuallyaccumulatedinpensionaccounts,

and

then"rolledover"toan

IRA.

The

aggregatedataillustratethe

growing

importance of

IRAs

and

401(k)s, butthey

do

not

indicate

how many

households

have

substantialbalances bothin

TDAs

and

intaxable accounts,

and

thus

face substantivelyimportantassetlocationproblems.

To

investigate

how

many

householdsfallin this

group,

we

usedata

from

the 1989, 1992, 1995,

and 1998

Surveys of

Consumer

Finances (SCFs).

The

SCF

isthebest availablesource ofdata

on

household wealth

and

its

components.

Itasksa relatively

comprehensive

setofquestions,hasa large

sample

size,

and

oversamples highnet

worth

households.

The

1998

SCF, which

isdescribed

by

Kennickell,Starr-McCluer,

and

Surette (2000),

sampled

4309

households, with

2813

inthe

random

sampleand 1496inthestratified

random

samplethatover-weighted

thosewith highincomesor net worth.

By

combining

anareaprobabilitysample withahigh-income

oversample,the

SCF

provides accurate information

on

broad populationcharacteristics,whilealsooffering

in-depthinformation

on

thehouseholdsthatholda disproportionateshareoffinancialassets

and

networth.

Four householdsareexcluded

from

the publicusedatasetduetodisclosureconcerns, leavinga

sample

with

4305

observations.

One

fourthofthehouseholdsinthesurvey

have

networth of overa milliondollars. All

of ourtabulationsweightthevariousobservationsinthesurvey

by

theirsampling weightssothatour

reportedstatisticsshouldberepresentativeoftheU.S.population.

We

measurethetotal valueofthe assetsheldintax-deferredaccountsas the

sum

ofassetsheldin

401(k)s, 403(b)s,IRAs, and supplementalretirementaccounts(SRAs).

We

excludethe valueofassets in

some

traditionaldefined contribution plansthat

do

notfallintothesecategories,since

some

oftheseplans

may

notallowparticipants

much

controlovertheirassetallocation decisions. Thisexclusionprobablyleads

ustounderstate the valueoftax-deferredassets thataredirectlycontrolled

by

individualinvestors.

A

similar

allocation

may

limitindividual controlof investmentoptions.

We

neverthelessincludeall401(k)planassets,

becausevirtuallyall401(k)participantscontrolassetallocationdecisionsforatleast

some

oftheirholdings.

Table 2presents

summary

information

on

thepercentageof households withtax-deferred accounts.

The

first

column shows

thepercentage withIndividualRetirement Accounts, 401(k)plans,403(b)plans,or

otherself-directedretirementsavingplans. This percentagerises

from

30.7percentin 1989to45.7percentin

1998.

The

next

column shows

thepercentageof households withfinancial assets,excludingtransaction

accountssuchascheckingaccounts, outsidetheir

TDA.

Approximately

45 percentofthehouseholds ineach

ofthefourSurveys of

Consumer

Financesreportownership oftheseassets. This percentage

would

be

much

greaterif

we

includedfinancialassetsintransactionaccounts.

We

exclude

them on

thegroundsthatthey

do

notreflectlong-terminvestmentpositionsinthe

way

that

TDA

balancesdo.

The

last

column

inTable 2

shows

thepercentageof households witheithertaxableor tax-deferredassets. Thisgroup accountsfor55

percentof householdsin 1989

and

63percentin 1998.

These

dataillustratetherapidgrowth duringthelast

decadeintheshareof households with

some

involvementin financialmarkets.

Table3 presents

more

detailedinformation

on

thesetof householdsthatfaceassetlocation

problems. It

shows

the

number

of households with

TDA

balances,and

non-TDA

balances,

above

various

thresholdlevels in 1989

and

1998. Assetthresholds are

measured

inconstant 1998dollars,

and

theshaded

entriesalongthe diagonal

show

theresults

when

we

applythe

same

thresholdtobothtaxableand

tax-deferred accounts.

The

assetthresholds

do

notadjust forthedeferred taxes associatedwithholdingsinside

TDAs,

or the greater prospectiveafter-taxreturnsassociatedwithassetsheldintheseaccounts. Poterba

(2002)suggeststhatfortime horizonsof

between

25

and

40

years,these

two

factorslargelyoffseteachother.

The

upperpanelof Table3presentsinformation

from

the 1989

SCF,

whilethelower panelpresents

data

from

1998.

The

lowerpanel

shows

that in 1998, 30.3 millionhouseholds

had

positive

amounts

of both

taxableandtax-deferredassets.

Over

halfofthesehouseholds

had

significant

amounts

inbothaccounts; 15.6

millionhouseholds

had

more

than $10,000inboth,while 10.3 millionhouseholds

had

more

than$25,000in

households,

had

more

than$100,000inbothtypesofaccounts. Thisgroup,

which

accountsfor justover3

percentofallhouseholds,heldalmost

42

percentofnon-transactionaccountfinancial assets.

Comparing

theentriesinTable3for1989

and

1998 demonstratesthe

growing

importance ofassets

intax-deferred accounts,and ofthe assetlocationissue. In1989, 8.6 millionhouseholdshad

more

than

$10,000, and2.6million

had

more

than$50,000,inbothtaxable

and

tax-deferredaccounts.

These

amounts

are

measured

in 1998dollars.

Between

1989and 1998, the

number

ofhouseholds withtax-deferredassets

abovevarious thresholds

grew

much

more

rapidlythanthe

number

of households withtaxableassetsabove

variousthresholds.

To

place tax-deferredassetholdingsinthebroadercontextof householdportfolios,Table

4

presents

information

on

the distributionoftheratioof

TDA

assets tototalfinancial assets for the 1998

SCF.

Asset

locationissuesare

more

importantforhouseholds withlarge

TDA

balances thanforthosewithsmall

balances.

They

arerelatively

more

importantforhouseholds with roughlysimilarholdingsinside

and

outside

their

TDAs.

Forahousehold withaportfolioalmostentirely inthetaxableaccount,the asset

mix

withinthe

401(k)

may

beoflittleconsequence,sincethe valueofthe401(k)atretirement

may

represent a smallfraction

oftotalwealth. Forahousehold with almostallofitsassets inthe

TDA,

theassetlocationdecisionisalsoof

littleconsequence

—

there

may

betoo

few

assetsoutside the

TDA

toallow

much

flexibility.

Table4

shows

that in 1998, the

median

household with bothtax-deferredandtaxablefinancialassets

had

57.1percentofitsfinancial assets ina tax deferred account.

At

the25thpercentilethisvalue

was

28

percent,whileatthe75thpercentileit

was

85.6 percent.

Thus

thereissubstantialdispersionintheshareof

assetsheldin

TDAs,

and

asubstantial

number

of households have

between

aquarter,andthree-quarters,of

their financial assets inthese accounts. Forhigher networthhouseholds,the distributionoftax-deferred

assets relative toallfinancial assetsshiftstowardtheleft.

The

median

valueofthisratioforhouseholds with

at least$250,000innetworth,forexample,is47.9percent,

compared

with57.1 percentforallhouseholds.

The

measure

ofnetworth usedforthiscutoffincludes non-financialassets,andif

we

limitour sampleto

households withfinancial assetsof

more

than$250,000,

we

findthatthe

median

household has only42.3

the networthandfinancial asset distributions,asubstantialgroup of households have

TDA

and

non-TDA

holdingsthatareofsimilarmagnitude.

Not

surprisingly,networthisstrongly correlatedwith

TDA

balances.

The median

networth of

households with

more

than$25,000inbothtaxableandtax-deferredaccountsis$510,000, whilethe

median

forthosewith

more

than $100,000inbothsettingsis$1.18million. Inbothcases,

mean

networthis

substantiallygreaterthan

median

($1.31 millionforthosewith

more

than$25,000inbothsettings,and $2.58

millionforthosewith

more

than $1 00,000).

Income

alsoriseswith

TDA

holdings.

Median

household

income

rises

from

$81,200forthosewith

more

than$25,000inboththe

TDA

andthetaxable account,to

$124,900forthosewith

more

than

$100,000

ineachsetting,whilethe

median

ageofthehousehold

head

rises

from

54to 56.

The median income

statistics

do

not capture asignificant

number

ofretiredhouseholds

withlargeholdingsof both

TDA

and

non-TDA

financial assets,butrelatively

low

currentincome.

2. AssetAllocation Patterns

The

datainthelastsectionsuggestthatroughlythirtymillionhouseholdsfacedassetlocation

decisionsin1998,andthatroughlyfifteenmillion

had

atleast$10,000inataxableaswellasatax-deferred

account.

A

substantialshareofthehouseholds withsignificant

TDA

balances

had

similarbalancesinside

and

outsidetheir

TDAs.

Forthesehouseholds,decisionsaboutassetlocationcanhaveanon-trivialimpact

on

theirlong-runfinancialstatus. Considera45-year-oldcouplewith$100,000ina

TDA,

and

the

same amount

ina taxable account.

Assume

thatthecouplefacesa

28

percentmarginal

income

tax rate

on

interest

and

dividends,

no

capitalgainstax,

and

thatboth

bonds

and

stocks yield returnsof7 percent peryear,butallof

the

bond income

iscurrentlytaxablewhileonly 2percentoftheequityreturn,thedividendyield,istaxable.

Ifthecoupleallocates the

TDA

tostocks

and

thetaxableaccounttobonds,

and

makes no

subsequent

reallocationdecisions,thenatage70,netoftaxespaidtowithdrawassets

from

the

TDA,

theywillhave

$732,650.

By

comparison,ifthey invest the

TDA

inbonds and holdequityin theirtaxable account,the

lowertaxburden

on

the

bond income

that results

from

holdingbondsinthe

TDA

will result inanafter-tax

8

thatcould haveimportanteffects

on

financialstatus. Inthissection,

we

usedata

from

theSurvey of

Consumer

Financesto investigate assetallocationpatterns,andtheninthenextsection,

we

considerasset

location.

2.1 Survey of

Consumer

Finances Information

on

AssetAllocation

For

most

typesoftax-deferredaccounts, theSurvey of

Consumer

Financesaskswhethertheaccount

isinvested 'mostly orallinstock','split

between

stockandinterestearningassets',or"mostlyorallin

interest-bearingaccounts,"orin "real estate,""insurance,"or"other." Hardly

any

TDA

assets areheldinreal

estate,insurance,or"other."

We

usethisinformationtoconstructestimatesoftheassetcompositionof

tax-deferred accounts,

and

to

compare

theseestimateswithcomparableestimates

on

thecomposition oftaxable

accounts.

We

allocateall oftheassets inaccountsidentifiedas'mostly orallinstock' toequity,halfofthe

valueof'split' accounts,and

none

ofthevalueofotheraccountstoequity.

We

then

sum

these equity

holdings,aswellas thetotalvalueofallaccounts.

The

SCF

doesnot distinguish taxableand tax-exempt

bondsinthe

TDA,

butbased

on

evidenceinBarber

and

Odean

(forthcoming),

we

assume

thatthereare

no

tax-exemptholdings.

Forone group oftax-deferredaccounts, the

SCF

collects assetvalues but not thecompositionof

assets.

These

are theaccountsof households

who

had

a defined contributionplanataprevious job, but

who

have notyet rolledtheiraccounttoan

IRA

ortakencashdistributions

from

theplan. Nearlythreehundred

thousandhouseholds have suchaccounts.

We

includedthesehouseholdsinour

summary

tabulationsinthe

precedingsection,butinthisandlatersections,

we

exclude them.

The

SCF

asksrespondentstoseparately reportthe dollarvaluesofdirectstock holdings, equity

mutual fundshares,

and mixed

equity-fixed

income

mutual fundsharesthatareheldoutsidetax-deferred

accounts. Aggregatingthesereportedassetholdingsprovides a

measure

ofequityheldintaxableaccounts.

We

do

not include equityinprivately-heldcompanies,sincesuchassets

may

beilliquidanddifficultto

transfer

from

the taxabletothetax-deferredaccount.

The

SCF

alsoprovidesconsiderabledetail

on

fixed-income

assetsheld outsideoftax-deferred accounts.

Our

measure of fixed-income assetsincludescertificates

foregoinganalysis,

we

excludethe valueof checking accounts

and

money

marketaccounts,

on

thegrounds

thatholdingsoftheseaccountsare driven

by

liquidityconcernsratherthanassetallocationor taxissues.

Tax-exempt bonds

raisespecialproblemsforouranalysis.

While

theirrisk attributesaresimilarto

other fixed

income

securities, their

income

istaxedlessheavilythanthe

income from

taxablebonds.

The

holdersof tax-exempt

bonds

pay

implicitratherthanexplicittaxes,sothe effectivetaxburden

on

tax-exempt

bonds

equals the yieldspread

between

comparably-riskytaxable

and

tax-exempt bonds. Thisyieldspreadis

usually smaller than the topmarginal

income

tax ratetimes the taxable

bond

yield,soatleastforhouseholds

withrelativelyhigh marginaltaxrates,tax-exemptbondsofferahigherafter-taxreturnthan taxable bonds.

For

some

households,tax-exempt

bonds

may

thereforeofferaless risky,butlightly-taxed,alternativeto

taxableequity. In

some

of ourcalculations,

we

combine

tax-exemptbonds withequitytodescribehousehold

assetallocations

between

heavily-taxedandlightly-taxedassets.

Inthe 1

998

SCF,

4.8 percentofallhouseholdsreported

owning

tax-exempt bonds,

and

another 1.8

percentheldtax-exempt

money

marketaccounts. If

we

restrictourattention tohouseholdsthathave both

taxableandtax-deferredfinancial assets, 11.9percentholdtax-exempt bonds. Thisfractionhasdeclined;it

wasl6.3percentin 1989. In contrast,thepercentofallhouseholds

owning

tax-exempt

bonds

has

been

very

stable.

Most

ofthehouseholdsthat

own

tax-exempt

bonds

alsoholdtaxablefixed-incomesecurities. In

1998,ofthe4.9 millionhouseholds holding tax-exempt bonds, roughlyhalfa million reported

no

financial

assetsoutsidetheir

TDA,

and

one

millionheld

no

corporatestock.

2.2AssetAllocation Patterns

Our

analysisofassetlocationdecisionsfocuses

on

whether households holdequities in theirtaxable

accountsorintheirtax-deferredaccounts. Table5reportsthefirststepinouranalysis:

summary

information

on

theequityexposure of

SCF

households.

The

table also

shows

thepercentageof households

who

hold

fixed

income

assets,and tax-exemptbonds.

The

tablepresentscross-sectionalinformationanditalso

documents

recenttrends.

The

firstpanel

shows

thatequity rose

from

40.4 percentoffinancialassets in 1989

to69.7 percentoffinancial assets in 1998. Thisincreasereflectedboth highremrns

and

broadening

10

accountsrose

from

27.3percentto45.8percent,whiletheshareofinvestorsholdingfixed-incomeassets

remainedsteadyataround 50percent.

The

shareof households with anyequity orfixed-incomeassetsrose

from 54to63percentoverthistimeperiod,while theshareholdingtax-exemptbonds

was

steadyat

between

fourandfivepercent.

The

lowerpanelsof Table5present separateinformation

on

financial assetsheldinside,

and

outside,

tax-deferred accounts. In 1989, the equity shareofassetsheldin

TDAs

(34percent)

was below

the equity

shareintaxableaccounts(43percent).

By

1998,

68

percentof

TDA

assets

and

71 percentof

non-TDA

assets

were

heldin equities.

The

similarityofthestock-bond

mix

inside

and

outside

TDAs

raisesquestionsabout

theextentto

which

investorsareconsideringtax factors indecidingwhetherto locate assetsinsideor outside

the

TDA.

Table5 also

shows

thatthepercentageof

TDA

households withequityin their

TDA

rose

from

13.3 in1989to34.5in 1998.

Table5 focuses exclusively

on

householdsthat

own

equity,

and

it

documents

how

thesehouseholds

own

theirstock. There canbesubstantialtaxconsequencesassociatedwithdifferent

methods

ofequity

ownership. For example,investors

who

holdstockthroughequitymutual funds cede

some

controlovertheir

taxburdenstofundmanagers'capitalgainrealizationdecisions.

The

first

row

inTable 6

shows

that in 1989,

27.3percentof households

owned

stock. Thistotalcan bedisaggregated: 7.3percentheld equityonly

throughtheir

TDA,

6percentheldequitybothinside

and

outside the

TDA,

and

14percentheldequityonly

outsidetheir

TDA.

The

tablealso

shows

that 14 percentofallhouseholds(10.2

+

3.8)

had

onlydirectequity

holdings,while 6percent(1.1+1.1+1.8+2.0)heldat least

some

equitythroughamutualfund.

These

summary

statistics

changed

duringthe 1990s.

By

1998, 12.4 percentof households held

taxableequityonlythroughstock

owned

directly,while15.3percentheld

some

taxableequitythrougha

mutual fund(15.3

=

4.7+4.8+2.1+3.7).

The

percentageofthe populationholdingatleast

some

equity roseto

45.8 percentin 1998,

and

this

was

theresultofrising

numbers

who

held equityonlyina

TDA

(from7.3

percentto 18.1 percent) aswell asbothinsideandoutside a

TDA

(6percentto 16.4percent).

The

data

from

theSurvey of

Consumer

Finances

document

a

pronounced

trendtowardahigherfractionofequity

11

taxburdens

on

stocksand on bonds,sincethe effectivetaxburden

on

equitiesheldthroughintermediariesis

oftenhigherthanthat

on

buy-and-holddirectequity investments.

Table7 presents information similarto that inTable6, butitdoessoforthecaseof

bonds

ratherthan

stocks. For bonds,the difference

between

holdingassetswithina

TDA,

andoutsidesuchanaccount,isvery

importantfordeterminingtheeffectivetaxburden. Inadditionto splittingfixed-income investments

by

TDA

and

non-TDA

location,Table7 also distinguishes taxablefixed-income investmentsintaxableaccounts

from

holdingsof tax-exempt bonds. Table 7 does notsuggestany changesin

bond

ownershipthatarenearly as

pronouncedas thoseforstockownership. There

was

literally

no

change

between

1989 and 1998inthe

percentageof households

-

48.8

-

owning

fixed

income

assets.

Roughly

onequarterofthisgroupheld

fixed-income

assetsinsidetheir

TDA

butnotoutside,whilenearly halfheld fixed

income

assetsoutside the

TDA

butnotinside. There hasbeen

some

increase,

from

8.8percentto 13.1 percent,inthepercentageof

households with fixed-income investmentsheldonly throughtheir

TDA,

and

adecline,

from

25.6to22.7

percent, inthe setof households withfixed

income

heldonlyoutsidethe

TDA.

The

overwhelming

majority

of

SCF

households hold

no

tax-exempt bonds, althoughthose

who

do

holdthese

bonds

tendtobeinthe

highest networthstrata,

which

makes

theaggregateportfolioshareheldinthese

bonds

significant.

3. AssetLocation Decisions

We

now

exploreassetlocationchoicesinthe Survey of

Consumer

Finances.

We

begin witha

summary

ofthese choices. Table8 presentsinformation

on

the

number

of households

who

reportvarious

assetlocation patternsinthe 1998

SCF.

The

columns

ofthistableindicatewhether households have

tax-deferred accounts,

and

ifthey do,

what

assets(onlyequity, only bonds,

and

some

combination)theyholdin

theseaccounts.

The rows

describethe assets thatthehouseholds holdin theirtaxableaccounts.

We

combine

tax-exempt

bonds

withequitiesheldintaxableaccounts.

The

table

shows

thatthereare 46.2 million

households withassets intax-deferredaccounts; theseare thehouseholdsin

columns

two

throughfour.

Of

thisgroup, thereare30millionhouseholds withtaxableassetsoutside the

TDA.

Thisisthegroup of

12

We

definetax-minimizingassetlocation patterns asonesthatallocatefixed

income

assets to

tax-deferredaccountsbefore taxable accounts.

Households

thatfollowsuchassetlocation patternsarelabeledas

taxefficient.

The

entries inTable8thatarelightlyshaded correspondtoassetlocation patternscouldbe

tax-minimizing.

The

darklyshadedthe entriescorrespondtoinvestmentpatterns that

do

notappeartobe

consistentwithtax-minimization. Thereare 10.8millionhouseholds(23.4 percentofallhouseholds with

TDAs,

and 36

percentofthosewith

TDAs

as well as taxableassetsoutside the

TDA)

holdingonly

fixed-income

assets in their

TDAs.

Thisisagroupthatmight beallocatingtheirhighly-taxedassets to their

tax-deferredaccount. Less thanhalfofthisgroup,however,4.1 millionhouseholds,holds

any

equity outsidethe

TDA.

These households,

who

arefollowingastrict

"bonds

inthe

TDA,

stocksinthetaxableaccount"

allocationrulerepresentlessthanonetenthofthehouseholds withtax-deferredaccounts,

and

13.6percentof

thosewith both

TDA

and

non-TDA

financial assets.

Table8 also

shows

thatthereare2.5millionhouseholds with only

bonds

inthe

TDA,

and

onlybonds

outside the

TDA.

Thisgroup

may

alsobe followingatax-minimizingassetlocationstrategy,as

may

bethe

4.9 millionhouseholds with onlyequityin their

TDA

andin theirtaxableaccount. Forahousehold withrisk

tolerancethatpointstoward holding onlystocksorholdingonly

bonds

inbothsetsofaccounts, thereis

no

effective assetlocationdecision.

One

additional group, thosewith

bonds and

stocksinthe

TDA,

andstocks

inthetaxable account,couldalsobetax-rninimizing. Thisgroupconsistsof2.3millionhouseholds.

Adding

allofthesegroupsinthe lightlyshaded boxestogether,thereare 13.8millionhouseholds

~

29.9 percentof

allhouseholds with

TDA

assets,or

46

percent

of

thosewithboth

TDA

and

non-TDA

financial assets

- who

may

be following tax-minimizingassetlocationrules.

Table8 also

shows

thatthereisasubstantialgroupof householdsthathold both fixed-incomeand

equity investments, but

who

holdalloftheirequities inside theirtax-deferred account.

These

householdsare

indark-shadedentriesofthetable. Thereare 6.5(=3.3

+

3.2)millionhouseholdsthathold only

fixed-income

securitiesoutsidetheir

TDA,

while holdingeitherallequitiesora

mix

of

bonds and

stocksinthe

TDA.

These households appeartobe followingjust thereverseofthe"bondsinthe

TDA"

strategy. Another

13

Thereare9.7 millionhouseholdsthatreportonlyequityinthe

TDA

orbothequity

and

fixed-income

securities inthe

TDA,

and

holdingsof bothequityand fixed-incomeassetsoutsidethe

TDA.

These

households,likethose

who

hold

bonds

outside the

TDA

and

stocksinthe

TDA,

could probablyincreasetheir

after-tax financial assetsatretirement

by

adjustingtheirportfolio tohold

more

oftheirfixed-income

investmentsin theirtax-deferredaccount,whilepreservingtheir overallriskexposure.

The

entries inTable8useastark criterion forinclusionincategoriessuchas"onlyequityin the

TDA." To

capturehouseholdsthathave mostlyequityinthe

TDA, we

repeatedthecalculationsthatunderlie

thetableusing"greaterthan

80

percentofthe

TDA

investedinequity"inplaceofthe 100percent cutoffin

Table8.

We

made

similarchangesinourother categorizationcriteria,replacing

any

100percent cutoffwith

80percent,

and

percentwith

20

percent.

The

resultsarebroadlysimilartothe findingsinTable8,although

fewer householdsare classified asfollowingstrategies thatarenottaxminimizing

when

we

takethis

approach.

Of

the46.2 millionhouseholds with

TDA

assets,3.8millionhave

more

than80percentoftheir

TDA

inequity,

and

lessthan

20

percentoftheirtaxableaccountinequity. This

compares

with3.2million

households inTable8withall oftheir

TDA

inequity,andalloftheir

non-TDA

assets infixedincome.

The

number

of households followingassetallocation patternsthatarenot taxminimizing,

and

aredark-shadedin

thetable,dropsfrom16.2millionto 10.5million

when

we

usethelooser categorizationcriterion.

Summary

statisticslikethoseinTable8 provide a useful perspective

on

assetlocationdecisions.

We

havealsopresentedthisinformationina graphical format. Figure 1plotsthebivariate distributionof

householdasset allocationdecisionsintaxable as wellastax-deferredaccounts.

The

concentrationof

households with

TDA

equityallocationsofzero,50percent,

and

100percentreflectsinpartour procedure

forturning categoricalresponsesinthe

SCF

into quantitativemeasures.

The

figureshows, however,that

thereisa verysubstantialconcentrationof householdsinthe four cornersofthedistribution. Thereare

two

mass

pointsinthedistribution,correspondingto

more

than80percentequityallocationinboththe

TDA

and

outside the

TDA

(28.3 percentofthehouseholds with

TDAs

and

non-TDA

financial assets)

and

lessthan

twentypercent equityallocation(justover 10percent).

Amromin

(2002)presents similar information,

14

Figure 2 presents information similarto that inFigure 1,buthouseholdsare

now

weighted

by

the

total

amount

offinancial assets thattheyholdinside

and

outsidetheir

TDAs.

The

datainFigures 1and 2

takentogethersuggestthatthehouseholds with littleor

no

equityin their

TDAs

tendtobe low-wealth

households.

When

we

weight

by

financial assets,43.9percentofallhouseholds have

more

than80percent

oftheir

TDA

assetsinequity,

and

a similarfractionoftheir

non-TDA

assets in equity. Figure2demonstrates

that

most

ofthe assets intax-deferredaccountsareheldinaccountswith highallocations to equity,asthe data

inTable5suggested.

Table8

and

Figures 1 and2provide

some

insight

on

theextentto

which

householdsarepursuing

tax-minimizingassetlocationstrategies,but they

do

notofferaquantitative

measure

of

how

close

tax-inefficienthouseholdsare to tax -efficient points.

To

addressthisissue,

we

compute

the

amount

of wealththat

each household witha

TDA

and

non-TDA

financialassets

would need

to reallocate inordertoreach a

tax-efficientportfolio. Table 9

summarizes

the findings.

The

first

row

reportsinformation alreadypresentedin

Table8:thereare 16.2millionhouseholdsthatappeartobefollowingtax-inefficient strategiesbased

on

their

currentportfolioholdings.

The

second

row

asks

how many

ofthesehouseholds holdportfolios that

would

requireasset

movements

of

more

than

$2500

toreach atax-efficientpoint. For example,ahousehold witha

$2000

TDA

balanceinvestedinequity,

and

large

bond

holdings outsidethe

TDA,

couldbe broughttoa

tax-efficientpoint

by swapping $2000

of

TDA

equityfor debt.

Such

ahousehold

would

be countedas

tax-inefficient inthefirst

row

of Table9,but notinthesecond.

The

resultssuggestthatnearly halfofthe

households withtaxinefficientholdingsarewithin

$2500

ofatax-efficient point:only8.5millionofthe 16.2

milliontax-inefficienthouseholds cannot be broughttotax-efficiencywithassettransfersof

$2500

orless. If

we

allowforasset transfersof

no

more

than$10,000 per household,allbut 4.6 millionhouseholds can be

broughttothetax-efficient point.Thisresultsuggeststhat

by moving no

more

than 11.8 million

households*($10,000), or $118billion,

we

can

move

three-quartersofthetaxinefficienthouseholdstotax

efficient points.

The

informationinTable 9suggeststhatfor

many

ofthehouseholdsthatarefollowing

what

15

wealth they

would

accumulateundera taxefficientstrategy,

and

the

amount

theywillaccumulateifthey

continuetofollowtheircurrentstrategy.

Table 10 presents another calculationdesignedtoaddress theproximity ofexistingportfolios to

tax-efficient allocations. Itfocuses

on

thetotal

amount

of wealththat

must

bereallocatedtoachievea

tax-efficientallocation forallhouseholds with

TDAs,

ratherthan

on

the

number

of householdsthathave holdings

thatare inefficient

by

more

thanacertainamount. Sinceassetholdingsarehighly concentrated,resultsbased

on

households

and on

assetscandiffersubstantially.

The

first

row

inTable1 focuses

on

theuniverseof

households with

TDAs

and

positiveholdingsoffinancial assetsoutside the

TDA.

In 1998,thetotalbalance

in

TDAs

was

$2.64trillion.

To move

allhouseholds with

TDAs

toatax-minimizingassetlocation

would

requireassettransfersof $250.8billion,orjustunderonetenthof

TDA

assets. Thisisslightly

more

than

twice thetransfer,calculatedabove,that

would

bringallbut 4.6 millionhouseholdsto tax-efficientpoints.

Table 10also

shows

thepercentageofassets thatneedtobereallocatedtoachievetaxefficiencyfor

households

whose

assets

meet

various thresholdsfor

TDA

and

non-TDA

holdings. Forthosewithatleast

$250,000inbothtaxable

and

tax-deferredholdings,therequired reallocationis$83billion,orelevenpercent

of

TDA

assets.

The

required reallocation asapercentageof

TDA

assetsissmallestforthosewithsmall

holdings

-

those

who

do

not

have

atleast$25,000inboththeirtaxableandtax-deferred accounts. Forthis

group, thereallocation

needed

toachievetaxefficiency ($33.9billion)isonly4.3 percentoftotal

TDA

assets.

Thisreflectsthesmallersize

of

TDA

relative to

non-TDA

assetsforthisgroup,aswellasa greatertendency

toholdtaxablefixed

income

assets inthe

TDA

among

smallaccountholders.

Table 10 also

shows

theaggregateportfolioreallocation that

would

be

needed

to

move

householdsto

equal equity/fixed-income allocations insideandoutsideoftax-deferred accounts.

The

required reallocation

isnot

much

largerthan the

one

thatis

needed

to

move

allhouseholdstothetax-minimizingasset location.

The

comparison ofthese calculationssuggeststhathouseholds appeartobeslightlyclosertothe

tax-minimizing

outcome

thantoa defaultstrategy that

would

allocatethe

same

fractionof boththetaxableand

thetax-deferredaccountto equities.

The

third

column

of Table 10

shows

thereallocationthat

would

be

16

each household could hold $25,000infixed-incomeassetsoutsideofthe

TDA

for financialemergencies.

Such

abuffer stockmight beattractiveif,asin

Amromin

(2002) and

Huang

(2001),householdsface

random

shocksto theirexpenditureneeds

and

theycan

make

earlywithdrawals

from

tax-deferredaccounts onlyat

substantial cost.

The

required reallocation

when

we

allowfora buffer stockof

non-TDA

fixed

income

savingisonlyslightlysmaller thanthat

when

we

do

notconsidersuchabuffer.

The

notionofafinancialbuffer stock outsidethe

TDA

raisesan importantquestionabouttheextent

to

which

TDA

and

non-TDA

assets are substitutes. Forindividualsovertheageof 59Vz,

who

can

withdraw

assetsfrom

TDAs

withoutpenalty,thedegreeofsubstitutabilityisgreaterthanfor

younger

households

who

facewithdrawalpenaltiesof 10percent.

Depending on

the structureofthe

TDA,

there

may

alsobeother

factors,suchashardship withdrawalrestrictionsin401(k)plans, that limitthedegreeto

which

TDA

assets

cansubstitutefor

non-TDA

assets.

Our

analysisfocuses

on

the tax differences

between

assetsheldinsideand

outside

TDAs,

butnon-taxdifferencesshouldalsobe consideredinfuturework.

4. ExplainingtheDivergence

Between

Actual Asset Location

and Tax-Minimizing

Behavior

Thereissubstantialheterogeneity acrosshouseholdsin the asset allocations thattheychoseintaxable

and

TDA

accounts.

While

developingastructural

model

oftheoptimal

amount

ofequity ordebttoholdin

thetax-deferredaccount,giventhe

random

shocksfacinghouseholds,is

beyond

thescopeofthe current

paper,

we

canexplore

which

typesof households

make

tax-efficientassetlocation decisions.

We

do

thisin

threeways. First,

we

estimate probit

models

for the discretechoiceof whetherornot ahouseholdisinthe

tax efficientregioninTable8. Second,

we

estimate regression

models

toexplain the difference

between

the

shareofthetax-deferredaccountthatisheldinfixed

income

assets,andtheshareofthe financial asset

portfoliooutside the

TDA

thatisheldinfixed

income

assets. Finally,

we

estimate regression

models

in

which

thedependentvariableistheshareof

TDA

assets that

would

needtobereallocatedtobringthe

householdtoatax-efficient allocation.

We

considerthehousehold's marginaltaxrate,itsreportedrisktolerance,itsage,networth, and

17

rate,are readilyavailableontheSurvey of

Consumer

Finances.

Our

marginaltaxratevariableisanestimate

ofthehousehold's marginalfederal

income

taxrate

on

ordinaryincome,constructedusingthealgorithm

describedinPoterba and

Samwick

(forthcoming).

The

benefitof

making

atax-efficientassetlocation

decisionisincreasinginahousehold's marginal

income

taxrate.

We

thereforetestforanassociation

between

themarginaltaxrateandassetlocationpatterns.

Inourestimation,

we

report resultsbothfortheentiresample of households with

TDAs

and

non-TDA

financialassets(1709observations),

and

forasubsample ofthosehouseholds with

IRAs

(1410

observations).

Some

householdsinthesubsample have

TDA

holdingsonlyinan

IRA,

whileothershave

both

IRA

and

non-IRA

holdings.

When

we

analyze thesubsample with

IRA

holdings,

we

defineour

measure

oftaxefficiencyusingonlytheassetsheldintheIRA.

Thus

ahousehold with an

ERA

fullyinvested

inbonds,but a401(k) withsubstantialequity holdings,

and

equityholdingsina taxableaccountaswell

would

beclassifiedastax efficient inthesubsampleanalysis.

Our

rationale forfocusing

on

thesecondgroupisthat

some

households with 401(k) accounts

may

holdequityintheir

TDAs

becauseof

employer

restrictions

on

asset allocation.

Many

employers

make

401(k)matchingcontributionsin

employer

stock,

and

theyrequire

employees

toholdthisstockfor

some

periodoftime. Thiscouldresult in

some

households holdingequityin their

TDA,

even thoughthey

would

prefertochoosea

more

tax-efficient asset allocation.

We

have

no

way

toidentifyhouseholds with

constrained holdingsin their401(k)s, so

we

focusonly

on

IRA

holdingsbecause households have complete

discretioninallocatingtheseassets.

Table 1 1 presentsthe resultsof ourempirical analysisofthe cross-sectional determinantsofasset

allocation.

The

first

two columns

present estimatesofprobit

models

foradiscretedependentvariableset

equaltounityifthehouseholdexhibits a taxefficientassetlocationpattern,andzero otherwise.

The

basic

specificationis

(1)

Prob(TAXEFFi

=

1)

=

<D(p

+

5*MTR, + I

of AGE,

+

I

yk

*NETWORTH

ik

18

where

TAXEFF,

isanindicator variablefortaxefficiency,

and

0(.) denotesthestandard

normal

distributionfunction,and

we

include categorical indicator variables for age, networth,

and

household

income.

The

RISK

variables areresponsestothree

SCF

questionsthattrytoelicitahousehold's

preferenceswithrespecttotherisk-rewardtradeoff.

The

coefficientestimatessuggest apositive,althoughvariable, relationship

between

household

marginaltaxratesandthetax efficiency

of

ahousehold'sassetlocation choices. Forthefullsample,the

coefficient

on

thetaxvariableispositive,butstatisticallyinsignificantly different

from

zero. Itislarger in

absolutevalue,

and

statisticallysignificantly differentfromzero, forthe

IRA

subsample.

The

resultswith

respecttothemarginaltaxratecoefficientsaresensitive,however,tothe other variables includedinthe

equation. Eliminatingthecategoricalvariablesforhousehold income,forexample, reducesthemarginaltax

ratecoefficient

and

in

some

specifications results ina negativecoefficientestimate.

Thereis

some

evidence of anage-related patternintax-efficiency.

Both

oftheestimated equations

show

asubstantiallylargeragecoefficientsforthe 60-69year oldagegroupthanfor the50-59 yearold

group.

The

significance ofthese

two

agecategoriesisthatthe taxpenaltyforwithdrawals

from

tax-deferred

accountsiseliminatedoncethehousehold reaches age

59

54,therebyreducingtheimportanceof

precautionarysavingconsiderations.

Households

over age

60

are

more

likely to

have

tax-efficient allocations

thantheirslightlyyoungercounterparts.

We

experimented withexpandingthe specificationtoincludean

interactionterm

between

themarginaltaxrate

and

anindicatorvariableforhouseholds overtheageof60,but

we

couldnotreject the nullhypothesisthatthecoefficient

on

thisvariable

was

equalto zero.

Thereisonly

weak

evidence ofnetworth-related, or income-related, patternsinthe probabilityof

holdingatax-efficient portfolio.

The

specificationinthefirst

column

suggeststhathouseholds withnet

worth oflessthan$25,000are less likely to

make

tax-efficientchoicesthan otherhouseholdsare,but the

differences acrossnetworthcategories arenotstatisticallysignificant. Similarproblemsariseininterpreting

the

income

coefficients.

The

next

two columns

of Table 11,

columns

threeandfour, reportregression equations in

which

the

19

shareof

non-TDA

assets infixed

income

securities.

The

specificationincludes the

same

explanatory

variablesastheprobit

models

reportedinthefirst

two

columns:

(2) DIFF,

=

p

+ 8*MTR,

+

I

a

j

*AGE

1J

+

I

yk

*NETWORTH

lk

+Et]

c

*RISK,

c

+

2

p

s

*rNCOME

is

+

£,.

Once

again, theestimatedcoefficient

on

themarginaltax ratevariableissensitive toourchoiceofestimation

sample.

The

coefficients

on

themarginaltaxratearenegativeinthe

models

forboththefull sample

and

the

ERA

subsample.

The

coefficientisstatisticallysignificantly different

from

zeroforthesample with

ERA

holdings.

The

pointestimatefor this specification, -.412,impliesthataone percentagepoint increaseina

household's marginaltax rateleadstoa 0.4percent declineinthedifference

between

theshareof

fixed-income

assets inthetaxable

and

the tax-deferredaccount.

Thereis

some

evidence ofalink

between

networth andthedifferenceinasset allocations.Highernet

worth households appeartoholdahighershareoftheir

non-TDA

assets infixed

income

thanlowernetworth

households. Thisfindingistruefor the

ERA-only

sampleaswellas forthebroadersample. Itislargely

driven

by

a smaller

amount

of fixed-income holdinginthetax-deferredaccountsof highnetworth

households. Thereisonce again

some

evidenceofa differenceinassetallocationpatterns forhouseholdsin

theirfifties

and

sixties,witholderhouseholds

showing

asmallerdifferential

between

theshareoffixed

income

assets intaxableandtax-deferredaccounts. Thereare

no pronounced

patternsinthe assetallocation

patternsacross

income

groups,andthecoefficients

on

some

oftheadjacent indicator variablesfor

income

categoriesdiffersubstantially.

The

last

two columns

of Table 1 1 presentourlastempiricaltestof whethertax rates affect asset

location.

The

dependentvariableintheseregression

models

isthepercentageof

TDA

assets thatneedtobe

reallocatedinordertoreach a tax-efficientallocation.

The

specificationisotherwisethe

same

as thatin

equation(2).

Once

againthemarginaltaxratevariablehas

mixed

effectsacrossspecifications.

The

coefficientestimateispositive

when

we

estimate the

model

forthefullsample,andnegative

when

we

estimateonthesample of

ERA

holders. Enneithercaseisthe coefficient

on

themarginaltax ratevariable

20

5. Conclusions

Thispaperpresentsevidence

on

assetallocation

and

locationdecisionsforhouseholdswith

substantial balancesinboththeirtaxableandtax-deferredaccounts. It

shows

that assetlocationisan

importantfinancialissueforasubstantialgroup ofU.S.households.

More

thanelevenmillionhouseholdsin

1998

had

atleast$25,000inbothtaxable

and

tax-deferredaccounts,

and

atleast3.4million

had

more

than

$100,000investedineachtypeofaccount.

Many

households havechosenassetlocationstrategies thatallocateequityto theirtax-deferred

account while theyareholdingfixed

income

investmentsintaxableaccount.

A

broad range ofstudiesbothin

academicjournalsandin outlets that areread

by

financialservices professionals,suchasCharron (1999)

and

Crain

and

Austin(1997), suggestthathouseholds canraise their after-taxretirementwealth

by

holding highly

taxedassets in theirtaxdeferred account,

and

lightlytaxedassetsoutside. Data

from

theSurvey of

Consumer

Financesneverthelesssuggestthattheequity shareoftax-deferredassetsisroughlyequaltotheequityshare

offinancial assetsoutsidethe

TDA.

The

costoftax inefficientbehavior

may

be modest,however,for

many

households.

Our

calculationssuggestthatforroughlythreequartersofthehouseholdsthatappeartodeviate

from

tax-efficientassetlocationstrategies,

moving

lessthan$10,000in

bonds

or stocks

would

bring

them

to

atax -efficient allocation.

The

limitedsizeofthisreallocationplacesanupper

bound on

theforegone

retirementwealthassociatedwithcurrentassetlocation decisions.

We

have

had

limitedsuccessinexplaining theassetlocation patternsthat

we

observein

cross-sectionalsurveydata. In the 1998 Survey of

Consumer

Finances,forexample,

we

findatbest a

weak

relationship

between

ahousehold'smarginal

income

taxrateandthetax-efficiencyofitsportfolio allocation.

Explainingthese patternsisclearlyachallengefor futurework,

which

shouldfocusboth

on

theinformation

thathouseholdsreceiveaboutassetallocationdecisionswithin tax-deferred accounts,

and

on

household

awarenessoftheafter-taxreturnconsequences ofdifferentassetlocationchoices.

The

assetlocationdecisionispartofabroader householddecisionaboutportfolio allocation.

Findingthat

many

households pursuetax-inefficient assetlocationstrategies raisesquestionsaboutother

21

one suchdecision:

consumer

borrowing. Data

from

the 1998

SCF

suggestthat

44

percentof U.S. households

haveoutstandingcreditcard balances. Moreover, 1 1.5percenthaveacreditcardbalance ofat least$5000,

and

more

than 18 percenthave

more

than

$2500

inoutstanding balances. Since 1986,interest

payments on

consumer

debthavenotbeendeductible

from

adjustedgross

income

forthepurposeof

computing

taxable

income. Interest

on

mortgagedebt,however, remainsdeductiblefor

income

taxpurposes.

The

taxdeduction

createsastrong incentiveforhouseholdsto

borrow

through

home

equitycredit linesratherthan

on

credit

cards

when

theycan.

Maki

(1996)

and

Stango (1999)suggest a declineinbothcreditcarddebt

and

inauto

loan financingafter

TRA86,

along withanincreasein

mortgage

borrowing.

Inspiteofthetaxincentives,thereappeartobeasignificantminorityof households withcreditcard

balances

who

couldgeneratesubstantialtax savings

by

increasingtheiruseof mortgagedebt.

Our

preliminary estimates suggestthat

among

the 18 percentof households withat least

$2500

inoutstanding

consumer

debt,5.4percent,orjustunderonethirdofthegroup, haveatleast$50,000inself-reported

housingequity. Nearly one seventh ofthisgroup, or2.3percentoftheaggregate population,hasatleast

$100,000inhousingequity. Itispossiblethatthetransactionscostsassociatedwithestablishinga

home

equitylineoutweighthe taxsavingfor

some

households,particularlythose

who

do

not itemize

and

who

do

notexpecttomaintaintheircreditcardbalanceforverylong. Nevertheless,it

seems

that

many

ofthe

same

issues that arise inexplainingapparentlytax-inefficient assetlocationdecisionsalso arisewithrespectto

consumer

borrowingdecisions.

Work

iscurrently

underway on

these,

and

otherrelatedhouseholdfinancial

REFERENCES

Amromin,

Gene

(2002), "PortfolioAllocationChoicesin

Taxable and

Tax-Deferred Accounts:

An

Empirical Testof

Tax

Efficiency,"

mimeo,

Universityof

Chicago Department

of

Economics.

Barber,

Brad

M.

and

Terrance

Odean

(forthcoming), "Are Individual Investors

Tax

Savvy?

Asset Location

Evidence

from

Retail

and

Discount

Brokerage

Accounts."Journalof Public

Economics

.

Bodie, Zvi

and Dwight

B.

Crane

(1997), "Personal Investing:Advice, Theory,

and

Evidence," Financial AnalystsJournal 53,

Number

6

(November/December),

13-23.

Charron,TerryS.(1999), "Tax-Efficient Investing for

Tax

-Deferred

and Taxable

Accounts," Journal of Private Portfolio

Management

(Fall),31-37.

Crain,TerryL.

and

JeffreyR. Austin(1997),

"An

AnalysisoftheTradeoff

Between

Tax

Deferred Earningsin

IRAs

and

Preferential CapitalGains," Financial Services

Review

6(4),227-242.

Dammon,

Robert,ChesterSpatt,

and Harold

Zhang

(2002).

"Optimal

Asset Location

and

Allocationwith Taxable

and

Tax

-DeferredInvesting,"

Mimeo,

Carnegie-Mellon

University.

Huang,

Jennifer (2001). "Taxableor

Tax

Deferred

Account?

PortfolioDecisions with Multiple Investment Goals."

Mimeo,

MIT

SloanSchool of

Management.

Kennickell,ArthurB.,

Martha

Starr-McCluer,

and

Brian Surette.2000.

"Changes

inU.S.

Family

Financesatthe

End

ofthe 1990s: Results

from

the

1998 Survey

of

Consumer

Finances." Federal ReserveBulletin (January).

Maki,

Dean

(1996), "Portfolio Shuffling

and

Tax

Reform,"

National

Tax

Journal 49,317-329.

Poterba,

James

(2002). "Valuing AssetsinRetirementSaving Accounts,"

mimeo,

MIT

Economics

Department.

Poterba,James,

John

Shoven,

and

Clemens

Sialm

(2001). "Asset Location forRetirementSavers,"in

W.

Gale,J. Shoven,

and

M.

Warshawsky,

eds.,PrivatePensions

and

PublicPolicies(Washington:

Brookings

Institution).

Poterba,James,Steven

Vend, and David

Wise

(2001).

"The

TransitiontoPersonal

Accounts and

IncreasingRetirement Weaith:

Macro

and

Micro

Evidence,"

NBER

Working

Paper 8610.

Samwick, Andrew, and James

Poterba(forthcoming). "Taxation

and Household

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Reforms

inthe 1980s

and

1990s." Journalof Public

Economics

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Shoven,

John

B. (1999).

"The

Location

and

Allocationof AssetsinPension

and

Conventional Savings Accounts,"

NBER

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Paper

7007.

Shoven,

John

B.

and

Clemens

Sialm(forthcoming). "Asset LocationinTax-Deferred

and

Conventional Savings Accounts,"JournalofPublic

Economics.

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"The

Tax Reform

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of

1986

and

the

Composition

of

Consumer

Debt." National

Tax

Journal52, 717-739.

Table 1: Self-DirectedTax-Deferred Assetsasa PercentofTotal Financial Assets

Year

IRA

DC

pension Total

1985

3.1%

5.5%

8.6%

1990 5.3 6.1 11.4

1995 6.9 7.9 14.8

1998 7.9 8.4 16.3

2001 8.5 8.3 16.8

Source:

Flow

of Funds,Z.l release,Tables

L.10

and

L.l19.c. Total financial assets

were

$8.0

trillionin 1985, $12.3trillionin1990, $18.6 trillionin1995, $27.2 trillionin1998,

and

$28.3trillionin

2001.

Table2: Percentageof

Households

with

Tax-Deferred Accounts

or FinancialAssetsOutside

Tax-DeferredAccounts,

1989-1998

Year

Tax

Deferred Assets

Taxable

Financial AssetsOutside

TDA

Either

Taxable

or

Tax

Deferred Assets

1989 30.7 45.6 55.1

1992 33.8 44.5 55.4

1995 40.7 43.1 58.4

1998

45.7%

46.8%

63.0%

Source: Tabulations

from

Surveysof

Consumer

Finances. Financial assets outside the tax -deferred account includestocks, equitymutual funds,certificates

of

deposit,savings bonds,

and

other taxable bonds.

Tax-exempt bonds

arenot includedinthesetoffinancial assetsoutside the

TDA.

In 1989,6.5 percent

of

households reported

some

holdingsoftax-exempt bonds;thisfraction

was

stableacross surveys, rising to 6.6 percentin 1998. Virtuallyallhouseholds

owning

tax-exempt

bonds

alsoheld taxablebonds.

The number

of householdsinthefourSurveys of

Consumer

Financesare

93

million (1989),95.9million (1992),

99

million (1995),

and

102.6million (1998).

Table3:

Households

withSignificant

Holdings

of

Both

Taxable

and

Tax-DeferredFinancial Assets

Value

of

Tax-Deferred

Account

Financial Assetsin

Taxable

Account

>0

_>10K

_>25K

_>50K

_>100K

1989

>0

-

A7

•* 11.2 8.0 5.9 3.6

>10K

13.1 8.7-: v;cj\, -;'.-6.8 5.1 3.2

>25K

8.0 5.9 4.8 3.8 2.4

>50K

4.4 3.6 2.9 '2.6 1.8

>100K

2.0 1.6 1.4 1.3 1-0 1998

>0

30.3 18.6 14.0 10.9 6.6

>10K

22.9 15.6 12.3 9.6 6.0

>25K

17.2 12.7 10.3 -; _{8.2 5.4}

>50K

11.9 9.2 7.6 6.2 - 4.3

>100K

6.9 5.7 5.0 4.1 3.2

Notes:

Each

entry

shows

thetotal

number

of

households(inmillions)withthespecified

mix

ofassets in

24

Table4: ShareofFinancialAssets

Held

in

Tax

DeferredAccounts, 1998

Net

Worth

or Financial

AssetCriterion

Millionsof

Households

with

TDA

&

Non-TDA

Assets

TDA

Assetsas aPercentage

of

Total FinancialAssets

For

Households

with

Both

TDA

and

Non-TDA

Assets

Percentile

Mean

10lh

25

th

Median

75th

90

th All

Households

30.3

10.6%

28.0%

57.1%

85.6%

97.3%

55.9%

Net

Worth

>$100K

22.6 9.1 24.8 54.1 83.4 96.3 53.8

Net

Worth >

S250K

14.3 6.8 19.6 47.9 77.9 94.5 48.9

Net

Worth

>$1M

3.4 4.1 13.4 34.7 68.2 88.2 40.7 FinancialAssets

>

$100K

15.3 7.3 20.9 49.2 79.0 94.7 49.8 FinancialAssets

>

$250K

7.4 5.7 15.3 42.3 69.4 93.3 44.2 FinancialAssets

>

$1M

1.6 3.0 7.9 25.0 51.5 85.1 33.3 Source: Authors'tabulationsusing1998

Survey

of

Consumer

Finances. Seetextfor furtherdetails.

Table5: Asset AllocationinTaxable and

Tax-Deferred

Accounts,

1989-1998

1989

1992

1995

1998

AllFinancial Assets

EquityasPercentage

of

TotalFinancialAssets :. - ?•

140$%':-

:47,8%

-DO.3/0 „ 69.7%:

>

Tax

Exempt Bonds

asPercentageofTotal FinancialAssets 13.5 12.0 9.6 6.2 Percentof

Households

with Equity or

Fixed-Income

Assets 54.0 54.5 56.7 62.6 Percentof

Households

with

Any

Equity 27.3 32.4 36.6 45.8 Percentof

Households

with

Any

Fixed-Income

Assets 49.2 48.6 48.4 50.5 Financial Assets

Held

in

TDA

EquityasPercentage

of

TDA

FinancialAssets 33.6 46.8 54.4

_67*sBHH

Percentof

Households

with Equityor

Fixed-Income

Assets 29.1 32.2 38.3 45.0 Percentof

Households

with

Any

Equity 13.3 19.9 24.7 34.5 Percentof

Households

with

Any

Fixed-Income

Assets 23.2 24.3 25.0 26.1 FinancialAssets

Held

inOutside

TDA

EquityasPercentage

of

FinancialAssetsinTaxable.;

Account

42.5 48.2

-

56.0 70;8 ./

Tax Exempt Bonds

asPercentageofTotal FinancialAssets 17.7 17.6 14.1 9.4 Percent of

Households

withEquityor

Fixed-Income

Assets 45.7 44.5 43.2 46.8 Percentof

Households

with

Any

Equity 20.0 21.0 22.3 27.6 Percentof

Households

with

Any

Fixed-Income

Assets 39.9 38.6 35.7 35.7 Source: Authors'tabulationsbased

on Survey

of

Consumer

Finances. Fixed

income

assets include holdings

of

tax-exemptdebt.