One of the first things that any beginning investor learns about is the strategy of asset allocation. By dividing your money among several different types of investments, you diversify your portfolio with the hope that when some of your investments fall in value, some others will rise in value to offset your losses. In statistical terms, a well-diversified portfolio includes groups of different investments that have little or no correlation with each other in the way their values change. If one investment goes down, the other investments act independently; they could go up, go down, or stay constant.

There are many tools to assist you in coming up with an appropriate asset allocation plan. Most financial planners agree that, in general, investment portfolios geared toward specific goals should take on higher amounts of risk for long-term goals and then grow more conservative as the need for the money approaches. Therefore, for a 30-year-old saving for retirement, an aggressive asset allocation would likely be advisable, while for a 63-year-old saving for retirement, one would recommend a more conservative asset allocation.

Once you have your asset allocation figured out, you're still not done. Even though you know how much money you will need to invest in each asset class, you still need to look at the money you currently have available and decide how to deploy it among your existing accounts and, if appropriate, the financial institutions you are currently using. You also need to look at the income tax consequences of your planned investments, taking into account whatever tax rules currently apply, as well as any anticipated changes that may come in the future.

Things get even more challenging when you have tax-favored accounts available such as traditional IRAs, Roth IRAs, employer-sponsored retirement plans, and 529 tuition savings plans. Each of these types of accounts has certain tax advantages over regular investment accounts. In order to take maximum advantage of these favorable tax provisions, you have to think about not only the overall asset allocation of your portfolio, but also which assets you will put into your various accounts, including the tax-favored accounts. This article will offer some help with deciding what accounts to use for your various investments.

Roth IRAs: The "A" is for "aggressive"
Congress gave investors an incredible boondoggle when it created the Roth IRA. With the opportunity for investors to earn income on their investments and pay no tax on that income -- even when withdrawals are taken from the account -- the Roth IRA is a highly attractive vehicle for high-growth assets.

Therefore, in deciding what assets should go in your Roth IRA, you should start with the part of your asset allocation that is likely to produce the highest return. You want to maximize the amount of income and capital gain that will flow from this account, because none of it will be subject to income tax at any point. Among the higher-risk asset classes that are often part of an overall financial plan are domestic stocks of small and mid-sized companies, international stocks, and high-yield bonds. In addition, if your financial plan includes investments in so-called alternative assets, such as equity hedge funds, real estate partnerships, timber, and commodities funds, the Roth IRA may also be the best place for those investments.

529 plans for growth
With the recent passage of the Pension Protection Act, the tax-free treatment of distributions from 529 tuition savings plans now extends beyond the original sunset phase-out date in 2010. For practical purposes, this means that as long as distributions from the 529 plan are used for qualified educational expenses, the earnings from investments within the 529 plan will be free from income tax. As a result, the same logic used above in discussing Roth IRAs also applies to 529 plans.

However, there are two reasons why using a slightly less aggressive asset allocation for 529 plans than for Roth IRAs may be prudent. First, the full tax benefits of 529 plans are available only for amounts that will eventually be used for educational purposes, so any appreciation in the account value above the total educational needs of beneficiaries will not be free of tax and in fact may be subject to penalties if withdrawn for other purposes. The Roth IRA is a better vehicle for potentially unlimited growth because its tax-free treatment is not limited by the eventual use of the money. Second, the fact that there is usually a shorter time horizon for educational needs than for retirement savings suggests taking a smaller amount of risk with money earmarked for education. While a 529 plan for an infant may well have a 20-year duration, as college gets closer and amounts within the account build toward the funding target, the need to take maximum risk will likely decrease.

Don't put municipal bonds in tax-favored accounts
Municipal bonds are tax-favored securities that provide interest that is free from federal and some state income tax. Usually, because of this benefit, an investor pays more for a municipal bond with a given income yield and maturity date than for a taxable bond with the same yield and maturity.

Because the interest from municipal bonds is already tax-free, using them in tax-favored accounts is at best unnecessary and at worst counterproductive. If you want to use bonds in a Roth IRA or 529 plan, you can generally get better returns from taxable bonds, and the interest will still be tax-free. With traditional IRAs, all distributions are subject to tax, so by using a municipal bond, you convert tax-free income to taxable income -- a terrible result.

So far, you've learned about where to put some of your highest-risk and lowest-risk assets. The second part of this article discusses large-cap domestic stocks and taxable fixed-income securities, which are medium-risk investments that compose the core of most investors' portfolios.

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Fool contributor Dan Caplinger welcomes your feedback.