Taxable and tax-deferred portfolio choices: Theory and practice

In chapter 1 of this dissertation, I investigate the empirical puzzle of tax-inefficiency in portfolio choices of the U.S. households. Tax efficiency is the dominant consideration in theoretical portfolio models that allow both taxable and tax-deferred accounts. Yet, empirically observed portfolio allocations are not tax-efficient. I offer a model that is designed to bridge the existing gap and validate its predictions on household-level portfolio data from the Survey of Consumer Finances. The model explicitly incorporates both the uninsurable labor income risk and accessibility restrictions that are an institutional feature of tax-deferred retirement accounts. Together, these elements create a tension between the desire to maintain tax-efficient allocations and concern over the need to make costly withdrawals from retirement accounts in the event of bad income draws. This leads some low-wealth households and households facing the highest penalties on withdrawals to forgo tax-efficient allocations in favor of allocations that provide more liquidity.;Chapter 2 provides a survey of existing theoretical and empirical literature on portfolio allocations in taxable and tax-deferred investment habitats. I identify the key factors in dual-habitat portfolio decisions and highlight the necessary ingredients for producing tax-inefficient allocations. In particular, I emphasize the importance of uninsurable labor income risk coupled with existing restrictions on accessibility of retirement assets. The chapter stresses the difficulties in obtaining tax-inefficient portfolio holdings with reasonable parameter choices for access penalties and severity of labor income shocks.;The model is shown to be consistent with some, though not all, aspects of cross-sectional observations of habitat-specific portfolio holdings. In particular, it predicts tax-inefficient portfolio holdings that are commonly observed in the data and relates the degree of tax-inefficiency to the strength of precautionary motives. On the other hand, the model mandates strict tax-efficiency for households not subject to accessibility restrictions—a prediction that does not have strong empirical support. The empirical results provide evidence that both the choice of a tax-inefficient portfolio and heterogeneity in portfolio allocations are related to the presence and severity of accessibility restrictions and precautionary motives.