2017 Fidelity® Personalized Portfolios Tax Management Review

Strategic Advisers' tax-sensitive management strategies1 help clients keep more of what they earn.

Chris Fusé, Portfolio Manager, Strategic Advisers, Inc.

One of our key goals for managing your Fidelity® Personalized Portfolios account is to help reduce the impact of taxes on your investment returns. According to Morningstar, investors' returns have been reduced, on average, by 1-2% each year,2 which could mean the difference of thousands of dollars. To help enhance after-tax returns, we applied a number of tax-sensitive investment management strategies throughout 2017.

Tax-sensitive investment strategies


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This chart is for illustrative purposes only.

Low volatility and an upward trending market reduced tax-loss harvesting opportunities

When an investment declines in value, we may sell it at a loss and replace it with an investment that has similar characteristics. We can then use that loss to help offset realized gains in the portfolio and potentially reduce the amount of capital gains taxes. In 2017, there were few opportunities for tax-loss harvesting. This was due to steady gains in U.S. stocks and a generally flat-to-positive return in fixed income. However, we did find opportunities in commodities and frontier markets, which are investments in countries that are less established than those in the emerging markets.

Market volatility can provide opportunity for tax-loss harvesting
Lower volatility in 2017 led to fewer opportunities for tax-loss harvesting than in years past. Source: S&P 500 Index and CBOE Volatility Index as of 12/31/2017.

Deferral of capital gains helped clients avoid paying higher taxes on short-term gains

Short-term capital gains are taxed at a higher rate than long-term gains. One of the most powerful tools for tax management is deferring a capital gain so that the lower long-term rate applies. When markets are generally moving up and tax-loss harvesting opportunities are rare, this can become an even greater priority. This was the case for 2017. Throughout the year, we applied our disciplined investment process and extensive research capabilities to rebalance client portfolios when appropriate. In doing so for each client, we sought to sell the most advantageous tax lots to reduce taxes.

A gain of $10,000 may be taxed differently depending on how long it's held

Short-term vs Long term

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This chart is for illustrative purposes only. Take a hypothetical investment with a pre-tax gain of $10,000. In this case, the potential tax savings available as the result of waiting for a year are $1,960, assuming the investor is the top marginal tax bracket. $10,000 (43.4%-23.8%)= $1,960. 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 43.4% = $4,340, with an after-tax return of 5.66%. 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%. Tax Information based on 2017 tax rates.

Managing exposure to fund distributions is important, as gains were higher in 2017 than 2016

Mutual funds are required to distribute any net capital gains that they have realized for the year. These gains are paid out to shareholders in the form of capital gains, which are taxed to the shareholder in the year they are received. Based on our proprietary research of publicly available information, the average total distribution in 2017 was higher than what we saw in 2016 for most asset classes, including U.S. and international stock funds. Your investment team seeks to manage the exposure to funds associated with those distributions. In many cases, our approach helped clients avoid unnecessary taxes by selling certain funds before they made large distributions, or by waiting to buy them until after the distributions were paid.

We managed exposure to large year-end distributions, particularly in U.S. and international stock mutual funds
This chart is for illustrative purposes only. Each account will hold shares of different funds that pay out distributions on different dates. Account owners may also need to pay taxes on some of these distributions, which could add to their tax bill.

Tax-efficient and tax-exempt investments helped reduce the impact of taxes—and contributed to strong returns

In each asset class, we seek to find investments that are tax-efficient for our clients. Some, like municipal bond funds, are used across most portfolios. Municipal bond funds can play an important role in balancing out the risks from other investments (such as stock funds) within client portfolios. In addition, while yields for municipal bonds sometimes appear lower than similarly rated taxable bonds, their after-tax yields may actually be more attractive for investors.

A closer look at after-tax yields shows that income from municipal bonds may appear more attractive
This hypothetical example shows annual income from a $10,000 investment in a taxable account. The municipal bond investment has a 2.14% assumed yield and the taxable bond yield is assumed to be 2.79%; actual investment results may vary. This hypothetical example is used for illustrative purposes only. It does not take into account state taxes, alternative minimum taxes, fees, or expenses. If it did, after-tax income might be lower. Tax information based on 2017 tax rates.

Other investments, such as Exchange-Traded Funds (ETFs) and Separately Managed Accounts (SMAs), are used where appropriate. In 2017, domestic stock ETFs and SMAs gave clients the benefit of strong returns, while being more tax-efficient in general. Based on their respective structures, ETFs tend to incur fewer capital gains taxes, while SMAs may have the ability to defer short-term capital gains and harvest losses.

Regardless of recent tax reform in Washington, our approach is unchanged

The Tax Cuts and Jobs Act signed in December 2017 brings forth a wide range of changes to the US tax code. However, there are no changes to how capital gains and dividends are taxed. This means our approach for tax-sensitive investing will not change. We will continue to seek out opportunities for tax loss harvesting, deferring capital gains, managing exposure to mutual fund distributions, and investing in tax-efficient and tax-exempt investments with the goal of helping you keep more of what you earn.

However, there were changes to personal tax rates and various deductions. Therefore, we encourage you to work with your tax advisor and Fidelity associate to ensure that we have the most up-to-date information regarding your specific tax situation. This information will help ensure that we are making the most informed decisions possible when making tax-sensitive decisions in your account.

Next steps

See your estimated tax savings

Log into your Fidelity Personalized Portfolios account, and on your Account Summary page, see "Track Your Potential Tax Savings."

Learn more

Read about tax-loss harvesting techniques used by your investment team

Call us at 1-800-544-3455

After you file your taxes, contact us with your updated information so we can better manage your account.