Tax-sensitive investment management is an ongoing process
We use 4 techniques as part of our approach
Harvest tax losses
Manage capital gains
Manage mutual fund distributions
Invest in municipal securities
Losses today may help reduce capital gains taxes in the future2
Our sophisticated, analytical approach helps us better identify when to realize the gains and losses that can help offset an investor's tax obligations. This powerful tax-sensitive investment strategy can have both an immediate and ongoing value to an investor.
How long an investment is held matters
The amount of time until long-term status is reached is important. Consider a $100,000 investment made 365 days ago that is now worth $110,000 (a gain of 10%). If the security were sold today, the tax bill would be $10,000 x 40.8% = $4,080, with an after-tax return of 5.92%. However, assuming the value has held steady, by waiting one additional day, the tax liability drops to $2,380, and the return increases to 7.62%.3
Investment gains are taxed at different rates depending on the length of time an investor holds an investment. Holding an investment longer can mean a lower tax rate. There are a number of factors to consider in determining the right time to realize a gain, including expected future return on the investment, individual tax rate, how long the investment must be held to get a more favorable tax rate, and how the holdings impact an investor's overall risk level.
We track every investment in an investor's portfolio and consider all these factors simultaneously across a large number of positions and tax lots. This helps us determine when it makes sense to realize gains in order to potentially reduce the impact of taxes across the portfolio.
Mutual fund distributions present an opportunity for tax-sensitive investment management
When mutual funds pay distributions to their shareholders, due to either investment gains realized through trading or from dividends, those distributions become taxable events. While it's possible for investors to manage distributions, it can be a very time consuming and complex process. Not only does the investor have to continually monitor the markets and develop a clear picture of each fund's potential future performance, they'll need to understand how and when each fund may pay out distributions and how those distributions may be taxed.
We use tax-sensitive investment strategies to monitor the funds held in each account in an effort to stay on top of the amount and timing of when those distributions will be paid out. We'll also work to avoid certain distributions where appropriate. For example, in some cases, it may make sense to move investments out of certain funds into other funds that pay lower distributions. This will depend on a range of factors, including the amount of time an investor has owned shares in the fund, the investor's current tax bracket, performance expectations, any unrealized gains they may have, and distributions paid by other funds in which the investor owns shares.
Depending on an investor's tax rate, our ability to avoid distributions could significantly reduce the taxes the investor may pay. With ordinary income tax rates as high as 39.6%3 and long-term capital gains taxed at a maximum rate of 20%,3 reducing distributions could make a big difference.
Tax-exempt securities may provide higher after-tax returns than equivalent taxable securities
When appropriate, we may invest in municipal bond funds in pursuit of higher after-tax returns. The interest on these bond funds is generally exempt from federal taxes and in some cases state and local taxes, depending on the fund and an account owner's state of residence.
Because the interest income paid out by these funds is exempt from federal taxes, their after-tax returns could actually be higher than taxable bond funds. That means that a municipal bond fund with the same coupon as a taxable bond fund could provide higher after-tax returns.
For example, among investors in the highest federal tax bracket, a 3% municipal bond yield can produce a tax-equivalent yield comparable to that of a taxable bond with a 5.07% yield.4
Our investment management team will determine whether municipal bond funds are appropriate for your situation. To do this, we'll consider a range of factors such as your individual tax rate, state of residence, and the characteristics of the individual state municipal market, including credit rating, bond issuance, volatility, and liquidity.
This hypothetical illustration assumes the investor met the holding requirement for long-term capital gains tax rates (longer than one year), the gains were taxed at the current maximum federal rate of 23.8%, and the loss was not disallowed for tax purposes due to a wash sale, related party sale, or other reason. It does not take into account state or local taxes, fees, or expenses, or the net gain's potential impact on adjusted gross income, which could impact exemption and deduction phaseouts and eligibility for other tax benefits.
Potential tax savings are based on the following calculation: (Realized Long-Term Losses x Long-Term Tax Rate) + (Realized Short-Term Losses x Short-Term Tax Rate). A 3.8% Medicare surtax may be added to tax rates, if applicable to your situation. If an investor subject to the alternative minimum tax (AMT), the appropriate AMT tax rate may also be added to the calculation.
Tax-sensitive investment management techniques (including tax-loss harvesting) are applied on a limited basis, at the discretion of the portfolio manager, primarily with respect to determining when assets in a client’s account should be bought or sold. With this discretionary investment management service, any assets contributed to an investor’s account that the portfolio manager does not elect to retain may be sold at any time after contribution. An investor may have a gain or loss when assets are sold.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.
Optional investment management services provided for a fee through Fidelity Personal and Workplace Advisors LLC (FPWA), a registered investment adviser and a Fidelity Investments company. Discretionary portfolio management provided by its affiliate, Strategic Advisers LLC, a registered investment adviser. These services are provided for a fee.
Brokerage services provided by Fidelity Brokerage Services LLC (FBS), and custodial and related services provided by National Financial Services LLC (NFS), each a member NYSE and SIPC. FPWA, Strategic Advisers, FPTC, FBS, and NFS are Fidelity Investments companies.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917