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What’s your after-tax asset allocation?

How do you calculate the asset allocation in your investment portfolio: before or after tax? The before- and after-tax allocations can be quite different and you could be taking on more risk than intended, claims Professor Moshe Milevsky in his new book, Your Money Milestones: A Guide to Making the 9 Most Important Financial Decisions of Your Life .
To use a simplified example, say you have $100,000 in bonds in a tax-deferred account such as an RRSP and $100,000 in stocks outside an RRSP. You might think you have $200,000 in capital with 50% allocated to bonds and 50% allocated to stocks.
Alas, you would be wrong, says Milevesky.
First, if your tax bracket is 40%, your net capital is only $140,000 because $40,000 in your RRSP and $20,000 on your stocks are owed to the tax man. They are liabilities. Second, your asset allocation would actually be 43% bonds and 57% stocks.
You have more equity than you think and you might want to lighten up on the risk, suggests Milevsky.
Note that in his book, Milevsky uses a different example where the capital-gains taxis not deducted, so that one’s net worth only reduces to $160,000. The reason for this is:”in theory you can ‘optimize’ your taxable gains by selling losers in the portfolio, to offset some capital gains, and continue this process for as long as possible, thus reducing the present value of your liability.”True, this liability won’t necessaily go to zero, but for simplification purposes,zero might be an acceptable number.
In any event, using Milevsky’s example, asset allocation is even more different than before tax. Theafter-tax allocation to stocks will be 62.5% and to bonds, it will be 37.5%. Even more reason to lighten up onstocks.