Taxable and Tax-Sheltered Accounts = Lower Returners with High Tax Costs

The key rules of thumb for asset location are that stocks go in taxable accounts and bonds go in tax-sheltered wrappers. But what about lowly old cash? From a pure tax standpoint, holding the assets in a tax-sheltered account makes the most sense, as income from cash investments is taxable as ordinary income, just like bond income.

Access is king in this case

Here's a case, however, where practical considerations may override the tax argument. One of the key benefits of cash is easy access to your money when you need it, so it simply may not make sense to store cash for near-term income needs in tax-sheltered accounts, where you may face taxes and other penalties to pull it out prematurely. And because you're receiving a minuscule income stream from most cash investments these days (you might be holding them for stability as much as real income), the tax hit associated with holding cash in a taxable account is apt to be quite low for most investors.

The bottom line is that if you're holding cash for near-term income needs or as an emergency fund, it makes sense to hold it in a taxable account. If you're holding a sleeve of cash as a component of your retirement portfolio's long-term strategic asset-allocation plan, it's fine to hold it within the context of your tax-sheltered account.