Asset allocation and asset location : household evidence from the survey of consumer finances PDF
Preview Asset allocation and asset location : household evidence from the survey of consumer finances
MITLIBRARIES 3 9080 02528 5955 Digitized by the Internet Archive in 2011 with funding from Boston Library Consortium Member Libraries http://www.archive.org/details/assetallocationaOOberg #1 b 531 1415 .cz- Massachusetts Institute of Technology Department of Economics Working Paper Series 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 MA Cambridge, 02142 This paper can be downloaded without charge from the Social Science Research Network Paper Collection at http://papers.ssrn.com/abstract_id=334741 MASSACHUSETTS INSTITUTE OFTECHNOLOGY AM 2 1 2003 ASSET ALLOCATION AND ASSET LOCATION: HOUSEHOLD EVIDENCE FROM THE SURVEY OF CONSUMER FINANCES Daniel Bergstresser Harvard Business School James Poterba MIT andNBER March 2001 Revised September 2002 ABSTRACT Therapid growth ofassets in self-directedtax-deferredretirement accounts has generated anew set of financial decisions formany households. In addition to decidingwhich assets to hold, households with substantial assets in bothtaxableandtax-deferredaccountsmustdecide where toholdthem. This paper uses data fromthe SurveyofConsumer Financesto assess how manyhouseholds have enough assets in both taxable andtax-deferredaccounts to face significant asset location choices. Italso investigates the asset location decisionsthese households make. In 1998, 45 percent ofhouseholds hadat least some assets in atax-deferred account, andmore than ten millionhouseholds hadat least $25,000 inbotha taxableandatax-deferred account. Manyhouseholds holdequities in theirtax-deferred accounts, butnot in theirtaxable accounts, while alsoholdingtaxable bonds intheirtaxable accounts. Most ofthese householdscouldreduce theirtaxesby relocatingheavily-taxed fixed income assets to theirtax-deferred account. Asset allocation inside and outsidetax-deferred accounts is quite similar, with about seventy percentofassets in each location investedinequitysecurities. Fornearlythree quarters ofthehouseholds thatholdapparentlytax-inefficient portfolios, a shift ofless than $10,000 in financial assets can move theirportfolio to atax-efficient allocation. Asset location decisions withinIRAs appearto be sensitive to marginal taxrates; we do not find evidence forsuch sensitivity in othertax-deferred accounts. We are grateful to Brad Barber, David Bradford, Joel Dickson, RogerGordon, Andrew Samwick, and John Shoven forhelpful conversations, to AmirSufi forassistance with the SurveyofConsumer Finances, andto the HooverInstitution, theNational Institute ofAging, andthe National Science Foundation forresearch support. Households have always faced the asset allocation problem, having todecide which assetsto purchase and howmuch toinvest ineach ofthem. But withthe recent growth ofself-directed retirement plan assets, manyhouseholdsnow also face an assetlocationproblem. This is the question ofhow much ofa given assetto hold in ataxable account, and howmuch ofit to hold in a tax-deferred account. Assets in participant-directedtax-deferred accounts totalednearlyfive trillion dollars atthe end of2001, with $2.4 trillion in Individual Retirement Accounts, and $2.3 trillion in401(k)-type plans. Atthe end of 1990, by comparison, there were $637 billion in IRAs, and $735 billion in defined contributionplans. Therecent growth ofIRAs, 401(k)'s, and otherself-directed tax-deferredretirement vehicles has drawn substantial interestto the investment decisions made byhouseholds withthese accounts. Asset locationhas begun to attract attention fromresearchers inpublic finance and financial economics, andit is a frequenttopic ofdiscussion among financial planners. Shoven (1998) outlined the structure ofthe asset locationproblem, andobserved thattax minimization wouldusually dictateholdingheavily-taxed taxable bonds inthe tax-deferred account, with less-heavilytaxed equities in the taxable account. Recent workbyDammon, Spatt, and Zhang (2002), Huang(2001), Poterba, Shoven, and Sialm (2001), and Shoven and Sialm (forthcoming) has offered furtherinsight onthe optimal assetmix forhouseholds facingvarioustax andfinancial circumstances. Absent liquidity orotherconsiderations, households should holdrelativelyheavilytaxed assets in theirtax-deferred account. Whetherthis implies thattaxable bonds should be held in the tax-deferred accountdepends on the set ofassets availableto the household. Forexample, Shoven and Sialm (forthcoming) considerthe asset location decision forinvestors who can onlyhold equities in the form of relatively tax inefficient vehicles, such as high-turnoveractively-managed mutual funds. Ifthese investors have access to tax-exemptbonds, then their optimal asset locationmay involve equitymutual funds in the tax-deferred account, and tax-exempt bonds inthe taxable account. Most ofthe recentresearch on asset location has focused on the derivation oftax-minimizing portfolio strategies,ratherthan on the analysis ofhouseholdportfolio choices. Three studies have presented empirical evidence on how households actually locate theirassets. The first, Bodie and Crane (1997), is based ona surveyofTIAA-CREF participants. It finds that investors choose similarasset allocations in theirtaxable and tax-deferred accounts, with little apparent regard forthe benefits oftax- efficient asset location. One open issue concerningthis research concerns theextent towhich the behaviorofTIAA-CREF participants can be generalized to thepopulation at large. A second study, Barberand Odean (forthcoming), is based on data drawn frombrokerage firm records. The data suggestthathouseholds hold equitymutual funds and taxable bonds intheirtax- deferred accounts, while theyhold individual equities in theirtaxable account. Because individual equity holdings tend to be less heavilytaxed than bonds orequity mutual funds, this asset location pattern is broadly consistentwithtax-minimizingbehavior. However, households are more likelyto trade stocks in theirtaxable than intheirtax-deferredaccount, even though trading in the tax-deferred account wouldnot generate current capital gains tax liability. A keyconcern withthis study is thedegree to which data on assets held through a single brokerage firm depictahousehold's broaderbalance sheet, and inparticular whetherhouseholds mayhave offsettingpositions at other financial institutions. Finally, athird study, Amromin (2002), uses data from the SurveyofConsumerFinancesto investigate whetherprecautionary demands forfinancial assets, coupledwith penalties and restrictions on withdrawingassets fromtax-deferredaccounts, can explain deviations from tax-efficient asset location patterns. Thepaperalsoprovides summaryinformation on tax-deferred account holdings. The findings suggest that the standard deviation ofhouseholdlaborincome is relatedto asset location choices, with households inless risky occupations choosingmore tax-efficientasset locations. Thispaperrepresents an important step towardbuildingmodels ofthe factorsthataffect assetlocation choices. In thispaper, we also use data from several Surveys ofConsumerFinances (SCFs) to analyze asset location decisions. The SCF data provide complete and disaggregate data onthe portfolios held bya large sample ofhouseholds. The SCF asks households to aggregate theirholdingsacross all financial intermediaries. This makes itpossible to studythe overall structure ofthe household portfolio, ratherthan just the structure ofone ofits components.
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