2018 Tax Management Review: For Fidelity Wealth Services® Tax-Sensitive Accounts

Helping clients keep more of what they earn

Chris Fuse, Portfolio Manager, Strategic Advisers LLC
Kristina Regan, CFA®, Vice President, Personalized Investment Management, Strategic Advisers LLC

Get in touch

Call us

800-544-3455


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

One of our key goals in managing your Fidelity Wealth Services® Tax-Sensitive account is to help reduce the impact of taxes on your investment returns. According to Morningstar, taxes have reduced returns, on average, by 1%–2% each year.1 This could mean the difference of thousands of dollars. This past year provided many challenges for investors. Increased market volatility, higher mutual fund distributions,2 and uncertainty about the direction of interest rates had an impact on client portfolios. To mitigate these challenges, we sought to enhance after-tax returns by applying a number of tax-sensitive investment management techniques3 throughout 2018.

Tax-sensitive investment techniques: 2018 highlights

Higher market volatility created more opportunities to harvest tax losses in your account

When an investment in your account 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 you owe. In 2018, there were increased opportunities for tax-loss harvesting, due to higher market volatility. Concerns about slower corporate earnings, rising interest rates, and the potential for increased tariffs weighed on investors. Throughout the year, we found opportunities to harvest tax losses in US, developed, and emerging market stocks, as well as domestic bonds, including municipal securities.


Market volatility provided opportunities for tax-loss harvesting

Line chart plots market volatility as measured by the VIX CBOE Volatility Index against the price of the S and P 500 Index for 2017 and 2018. In 2017, the S and P 500 Index rose steadily while market volatility fell. In 2018, the S and P 500 Index rose initially, but dropped sharply in February, ushering in a period of steadily rising market volatility. The S and P 500 Index was down overall for 2018 and starting in October, market volatility increased further.
Source: Factset, as of 11/28/18

Our efforts to manage 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 tax-sensitive techniques available is to put off realizing a capital gain so that the lower, long-term rate applies. Throughout 2018, we applied our disciplined investment process and extensive research capabilities to rebalance portfolios when appropriate. When the opportunity presented itself, we sought to sell investments that clients had held for a shorter time period in an effort to reduce clients' exposure to capital gains taxes. These short-term losses can also be used to offset short-term gains in client portfolios.


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

Alt text: Bar chart shows hypothetical example of taxes and after-tax gains on a $10,000 capital gain when sold as a short vs a long-term investment. In general, selling an investment that is subject to long-term capital gains taxes results in a greater after-tax profit, when compared to selling an investment that is subject to short-term capital gains taxes.

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 $1,700, assuming the investor is in the top marginal tax bracket. $10,000 (40.8%-23.8%) = $1,700. The amount of time until long-term status is reached is important. Consider a $100,000 investment made 300 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%. Tax Information based on 2018 tax rates.

Managing exposure to this year's higher mutual fund distributions helped avoid some unnecessary taxes

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 gain distributions, creating a taxable event for each shareholder in the year they are received. The average total distribution in 2018 was higher than what we saw in 2017 for most asset classes, including US and international stock funds.4 As a result of a 9-year bull market in US stocks, domestic stock funds, led by small-cap and growth stock funds, had larger distributions than their international counterparts.

Your investment team sought to manage the exposure to funds associated with those distributions. In many cases, our approach helped clients avoid unnecessary taxes. We sold certain funds before they made large distributions, or waited to buy them until after the distributions were paid.


We managed exposure to large year-end distributions, particularly in US and international stock mutual funds
A calendar for November and December shows how different funds in a hypothetical portfolio may pay distributions during the latter part of a calendar year. We generally seek to manage your exposure to some of these distributions in an effort to reduce the taxes on your investments.
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

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 taxable accounts. In 2018, uncertainty about the direction of interest rates led to volatility in the municipal market. Despite that, municipal bond funds continued to provide important diversification benefits. Within client portfolios, they helped to balance out the risks of other investments (such as stock funds). This was particularly important in 2018 as we saw domestic and international stock performance weigh on returns. When it comes to municipal bonds, it's important to remember that sometimes yields appear lower than similarly rated taxable bonds. When you factor in that interest is exempt from federal, and in some cases, state income taxes, their after-tax yields may actually be higher. That is why we continue to believe that municipal bond funds can play an important role in taxable accounts.


A closer look at after-tax yields shows that income from municipal bonds may be more attractive

Bar chart shows a hypothetical example comparing annual income from a $10,000 investment in a taxable account in a 10 year AAA municipal yielding 2.14% versus a 10 year AAA taxable bond yielding 2.79%. Taxable bonds with higher income look great at first glance, but once you adjust for federal tax rates, income from municipal bonds may be more attractive. Chart shows the municipal bond's pre and post-tax income is $214. This is lower than the taxable bond's pre-tax income of $279. But after taxes, the taxable bond only provides income of $212, $190, $171, and $165 across the different tax brackets (the 24%, 32%, 38.8%, and 40.8% tax brackets, respectively). Once your federal tax bracket has been factored in, municipal bond yields may be more attractive, with municipal bonds producing greater income than taxable bonds.
FOR ILLUSTRATIVE PURPOSES ONLY. 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 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 2018 tax rates. *Rate includes a Medicare surtax of 3.8% imposed by the Patient Protection and Affordable Care Act of 2010.

Other investments, such as exchange-traded funds (ETFs) and the individual securities held in separately managed account (SMA) sleeves are used where appropriate. In 2018, domestic stock ETFs and SMAs gave clients the benefit of strong returns, while being more tax-efficient in general. ETFs tend to incur fewer capital gains taxes, while SMAs may provide additional opportunities to defer short-term capital gains and harvest losses.

Regardless of last year's tax reform in Washington, our approach is unchanged

The Tax Cuts and Jobs Act, which went into effect in January 2018, brought forth a wide range of changes to the US tax code. While there were changes to personal tax rates and various deductions, there were no changes to tax rates for capital gains and dividends. This means our approach for tax-sensitive investing has not changed. We will continue to seek out opportunities to help you keep more of what your investments earn.

We also continue to monitor the ongoing impact of the trade disputes with our trading partners. We will look to adjust our portfolios if outcomes warrant. We otherwise do not expect any legislative tax impacts to our client portfolios. However, we will be continuously watching for any potential tax changes and act accordingly.

Next steps

estimated-tax-savings_illustration

See your estimated tax savings

Log in to your account, and on your account summary page, see "Track Your Potential Tax Savings."

advisor_illustration

Speak with your advisor

After you've filed your taxes, we encourage you to contact your Fidelity advisor and provide your most updated tax information. This will help us effectively manage the impact of taxes on your account.


We look forward to partnering with you throughout the coming year. Your Fidelity advisor remains dedicated to providing clear recommendations designed to help you grow and protect your wealth.

1. Taxes Can Significantly Reduce Returns data, Morningstar, Inc., 3/1/2018. This example reflects a 91-year period from 1926-2017 and is based on the following data: stocks: 10.2%, stocks after taxes: 8.2%, bonds: 5.5%, and bonds after taxes: 3.5%.

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. Stocks are represented by the Ibbotson® Large Company Stock Index. Bonds are represented by the 20-year U.S. government bond. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for transaction costs.

Federal income tax is calculated using the historical marginal and capital gains tax rates for a single taxpayer earning $120,000 in 2015 dollars every year. This annual income is adjusted using the Consumer Price Index in order to obtain the corresponding income level for each year. Income is taxed at the appropriate federal income tax rate as it occurs. When realized, capital gains are calculated assuming the appropriate capital gains rates. The holding period for capital gains tax calculation is assumed to be five years for stocks, while government bonds are held until replaced in the index. No state income taxes are included. Stock values fluctuate in response to the activities of individual companies and general market and economic conditions. Generally, among asset classes, stocks are more volatile than bonds or short-term instruments. Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns. U.S. Treasury bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate. Although bonds generally present less short-term risk and volatility than stocks, bonds do entail interest rate risk (as interest rates rise, bond prices usually fall, and vice versa), issuer credit risk, and the risk of default, or the risk that an issuer will be unable to make income or principal payments. The effect of interest rate changes is usually more pronounced for longer-term securities. Additionally, bonds and short-term investments entail greater inflation risk, or the risk that the return of an investment will not keep up with increases in the prices of goods and services, than stocks.
2. Source: Strategic Advisers LLC, as of 12/31/2018. We monitor the funds held in each account in an effort to stay on top of the amount and timing of when mutual fund distributions will be paid out, for both Strategic Adviser Funds and other mutual funds.
3. Tax-sensitive investment management techniques are applied in managing taxable accounts (including "tax-loss harvesting") on a limited basis, at the discretion of Strategic Advisers primarily with respect to determining when assets in a client’s account should be bought or sold. As a discretionary portfolio manager, Strategic Advisers may elect to sell assets in an account at any time. A client may have a gain or loss when assets are sold. Strategic Advisers does not currently invest in tax-deferred products, such as variable insurance products, or in tax-managed funds, but may do so in the future if it deems such to be appropriate for a client. Strategic Advisers does not actively manage for alternative minimum taxes; state or local taxes; foreign taxes on non-U.S. investments; or estate, gift, or generation-skipping transfer taxes. Strategic Advisers relies on information provided by clients in an effort to provide tax-sensitive investment management, and does not offer tax advice. There are no guarantees as to the effectiveness of the tax-sensitive management techniques applied in serving to reduce or minimize a client’s overall tax liabilities, or as to the tax results that may be generated by a given transaction. Except where Fidelity Personal Trust Company (FPTC) is serving as trustee, clients are responsible for all tax liabilities arising from transactions in their accounts, for the adequacy and accuracy of any positions taken on tax returns, for the actual filing of tax returns, and for the remittance of tax payments to taxing authorities.
4. Based on our proprietary research of publicly available information. Source: Strategic Advisers LLC, as of 12/31/2018. We monitor the funds held in each account in an effort to stay on top of the amount and timing of when mutual fund distributions will be paid out, for both Strategic Adviser Funds and other mutual funds.
Diversification/asset allocation does not ensure a profit or guarantee against loss.

Past performance is no guarantee of future results.

Exchange-traded products (ETPs) are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, foreign securities, commodities, and fixed income investments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector, are generally subject to greater market volatility, as well as to the specific risks associated with that sector, region, or other focus. ETPs that use derivatives, leverage, or complex investment strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses, and tracking error. An ETP may trade at a premium or discount to its net asset value (NAV) (or indicative value in the case of exchange-traded notes). The degree of liquidity can vary significantly from one ETP to another and losses may be magnified if no liquid market exists for the ETP's shares when attempting to sell them. Each ETP has a unique risk profile, detailed in its prospectus, offering circular, or similar material, which should be considered carefully when making investment decisions.
Generally, among asset classes, stocks are more volatile than bonds or short-term instruments and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Although the bond market is also volatile, lower-quality debt securities including leveraged loans generally offer higher yields compared to investment grade securities, but also involve greater risk of default or price changes. Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets.
The municipal market can be affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal funds. Although municipal funds seek to provide interest dividends exempt from federal income taxes and some of these funds may seek to generate income that is also exempt from the federal alternative minimum tax, outcomes cannot be guaranteed, and the funds may generate some income subject to these taxes. Income from these funds is usually subject to state and local income taxes. Generally, municipal securities are not appropriate for tax-advantaged accounts such as IRAs and 401(k)s.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
An investment cannot be made in any index.
S&P 500® Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.
CBOE Volatility Index is a weighted average of prices on S&P 500 Index options with a constant maturity of 30 days to expiration. It is designed to measure the market’s expectation of near-term stock market volatility.
This material may not be reproduced or redistributed without the express written permission of Strategic Advisers LLC.
Fidelity® Wealth Services provides non-discretionary financial planning and discretionary investment management through one or more Portfolio Advisory Services accounts for a fee. Advisory services offered by Fidelity Personal and Workplace Advisors LLC (FPWA), a registered investment adviser, and Fidelity Personal Trust Company, FSB (FPTC), a federal savings bank. Nondeposit investment products and trust services offered through FPTC and its affiliates are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency, are not obligations of any bank, and are subject to risk, including possible loss of principal. Discretionary portfolio management services provided by Strategic Advisers LLC (Strategic Advisers), a registered investment adviser. 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