Are Bonds Desirable in Tax-Deferred Accounts?
37 Pages Posted: 7 Jul 2007 Last revised: 25 Jul 2008
Date Written: February 7, 2008
This paper analyzes the consumption investment problem over the life cycle for investors with tax-deferred investment opportunities. According to the classical result of Black (1980) and Tepper (1981) with unlimited borrowing and short-selling, bonds should be exclusively held in these accounts. We argue that in tax-systems like the US where tax rebates on capital losses are limited, this is not necessarily true. Since a tax loss carry-forward is a less attractive compensation than an immediate tax rebate payment, the different taxable treatment of realized capital gains and losses increases the desirability of holding stocks in tax-deferred accounts. Our results suggest that this feature of the tax-code can help explaining why private investors violate the Tepper-Black result and hold stocks in their tax-deferred accounts.
Keywords: asset location, asset allocation, limited capital loss deduction, tax-deferred accounts, loss carryforward, asset location puzzle
JEL Classification: G11, H24
Suggested Citation: Suggested Citation