The Two Layer Cake Portfolio

The Two Layer Cake Portfolio

The decision to split an investment portfolio into two distinct asset allocations is not a piece of cake, but we can call it a two-layer cake. This cake solves the problem of how to manage for the current generation which may have a fixed income orientation and use the remainder to grow for the next generation or two.

Asset allocation and asset location, two different concepts, come into play even more when folks have acquired cash and securities way beyond their lifetime income needs. This usually involves cash, stocks, and bonds greater than $1.5 million in my experience.

Traditionally, asset location was addressed by investment managers and financial planners who organized retirement accounts to be more heavily weighted with fixed income securities. Because retirement account withdrawals are taxed at ordinary rates, heavily weighted fixed income portfolios were designed. Conversely, a larger percentage of stocks were placed into taxable accounts to take advantage of lower capital gains tax rates and even a step-up in basis at death.

This strategy was summarized in an overall target allocation that might be 55% stocks and 45% fixed income. The retirement accounts might be 35% stocks and 65% fixed income while the taxable accounts might be 70% stocks and 30% fixed income, as an example. This kind of overall portfolio was designed to last two or more decades for retirees.

The two-layer cake strategy comes into play when a much more aggressive portfolio is utilized in taxable accounts to grow for the next generation or two. In some cases, the taxable accounts reflect 100% stocks (equities). Dividends and capital distributions go to the retirees, while recognizing that the aggressive taxable portfolio is a 40 year plus strategy destined for future generations.

In cases where most or all assets are in retirement accounts, the two-layer cake strategy isn’t as tax beneficial but can still provide a larger benefit from mentally accepting that the more aggressive overall asset allocation will mean future generations can benefit from stock market growth. In that situation, an overall target allocation might evolve from a 55% stock/45% fixed income allocation for the first $1.5 million and a 90/10 allocation for the assets above that level to achieve sufficient income for retirees and greater growth for future generations.

In this kind of dual agenda strategy, you can have your cake and eat it too.

 

 

Jim Ludwick
Jim Ludwick
jim@mainstreetplanning.com

Jim Ludwick is the founder of MainStreet Financial Planning. His varied education and life experiences have enabled him to apply his knowledge and experience into useful solutions for personal financial problems. His writing and broadcasting activities allow him to help many more than just individual clients. He loves a microphone.

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