If your desired allocation is 60/40 and you adjust so you end up being closer to 50/50, your long-term returns will reflect a 50/50 allocation and then, sometime in the future, you pay taxes. If you don’t adjust, your long-term returns will reflect the 60/40 allocation and then, sometime in the future, you pay taxes.

Also (and I think this probably one of the most compelling arguments), by adjusting as you proposed, you are essentially deciding to account for and invest a separate pool of funds specifically to meet far-off, future tax liabilities from retirement account distributions 100% in bonds.

As far as I can tell, that’s precisely the detriment of not tax adjusting.

To me, if an investor expects a 25% tax bracket in retirement, then that means that he only benefits to the extent of 75% of the assets in his 401k. It seems to me that it follows that he must adjust everything that happens in that account to the degree of 25%.

For example, he’s only affected to the extent of 75% of fluctuations in the account value. To ignore that seems to set him up for a different risk/return profile than intended.

But it doesn’t stop there. Whether or not they use a “tax-adjusted” allocation, they will still have to pay the taxes on distributions from the tax deferred accounts (each distribution will likely be only a small amount relative to the total balance). Assuming the amount of the distribution is the same in either approach, the taxes will also be the same. If they are diligent in rebalancing, even using the cash out-flow to minimize to assist, they can maintain their desired target allocation post distribution. So the potential for a few more decades of experiencing the pre-tax risks and rewards of the adjusted allocation continues. So where exactly is the benefit of adjusting the allocation for tax-deferred assets? The detriment is multiple decades of actual exposure to a different risk/return profile than what was actually intended.

Then there’s the dilemma about where to hold emerging markets stocks. Assume we have a hunch EM stocks will outperform. To avoid capital gains, hold them in the Roth. But to claim foreign tax deduction, you want them in the taxable.

Throw in a 401k, a few more securities, and perhaps limited investment options in some accounts, and it all gets very complicated. If someone could show scenarios where one strategy is clearly preferred over another, that might be useful.

Also, one Mike P shared this link from the Bogleheads wiki: http://www.bogleheads.org/wiki/Tax-Adjusted_Asset_Allocation

Here is another way to look at it using the example in the post. The total portfolio is worth $100,000, but after-tax it is only worth $90,000. You can apply you 60/40 allocation to the $90k that is yours and then apply it again to the $10K that is Uncle Sam’s. Then implement both of those allocations in the most favorable, tax-advantaged accounts. Some of Uncle Sam’s money will be invested in stocks in the taxable account, but so what? If you think it matters, lay it out on a spreadsheet, and you will see it does not.

To sum up, in a round-a-bout way I think the new idea in our exchange is that there is a balance between the two dimensions of constraints: AA and taxes. If both post a significant issue for one or another vehicle, then one needs to do some thinking. Juicing the account by the tax rate may be foolish (my 99% example).