As I discussed in a recent article
, a low-return environment puts the onus on investors to do more of the heavy lifting--spending less and saving more--to keep their plans on track. And because investors will need every basis point of return they can earn, they'll also benefit from playing small ball--being parsimonious about investment and tax costs, for example.
Fidelity's lineup is a good fit for investors aiming to build low-cost, tax-efficient portfolios. While not every fund in the firm's stable is inexpensive and/or tax-efficient, Fidelity does field top-flight index and municipal-bond funds. Both sets of products tend to have low costs and keep taxable distributions to a minimum.
Let's take a look at how younger investors--those still working and accumulating assets for retirement--could build low-cost, tax-friendly portfolios using funds from the Boston-based giant. Whereas our Fidelity Saver portfolios
are geared toward investors in tax-deferred accounts like 401(k)s and IRAs, these portfolios are appropriate for investors' taxable accounts.
I created three tax-efficient Fidelity Saver portfolios: Aggressive, Moderate, and Conservative. I used Morningstar's Lifetime Allocation Indexes
to guide their asset-class exposures. I employed Morningstar's medalist funds
--primarily Fidelity municipal-bond and indexed equity funds--to populate them. I specified the lowest-minimum share class for these portfolios, but investors should, of course, opt for the lowest-expense share class they qualify for.
Investors should also be sure to keep asset-location and time-horizon considerations in mind when deciding what to put into their taxable portfolios. Because equities tend to be more tax-efficient than taxable bonds, conventional wisdom holds that accumulators should maintain an equity-heavy stance in their taxable accounts while holding more bonds in their tax-sheltered accounts. In fact, a 30-something could reasonably hold all of his or her bond funds (presumably a modestly sized stake) in his IRA and 401(k), while holding only stocks inside of the taxable account. But time-horizon considerations might suggest they do just the opposite: If they're saving for shorter-term, nonretirement goals in those accounts, they'd likely want to hold more cash and bonds than are depicted in these portfolios.
Aggressive Tax-Efficient Saver Portfolio
Time Horizon Until Retirement: 40 Years | Risk Tolerance/Capacity: High | Target Stock/Bond Mix: 90/10
10%: Fidelity Intermediate Municipal Income
30%: Fidelity Spartan Global ex-US Index Advantage
60%: Fidelity Spartan Total Market Index Advantage
Geared toward a young accumulator, the Aggressive Fidelity Tax-Efficient Saver mutual fund portfolio uses the allocations of Morningstar's Lifetime Allocation 2055 Aggressive Index to guide its weightings. That index devotes more than 90% of its assets to stocks, including a healthy dose of foreign names. Thus, anyone considering such a portfolio should not only have a long time horizon but should also be able to tolerate the volatility that can accompany a very high equity allocation. Although the Lifetime Allocation Indexes call for a dash of commodities and TIPS exposure for inflation protection, neither of those asset classes is tax-efficient, so I didn't include them here.
I used two broadly diversified equity index funds for the bulk of the portfolio--a larger position in a total U.S. market tracker and a smaller stake in a fund that tracks the MSCI All Country World ex-US Index. Both feature low costs and broad diversification. Fidelity Spartan International Index
has lower costs and a Silver rating, but I employed the Global ex-US fund because it encompasses emerging markets and is, therefore, a better one-stop option, especially for younger investors who can handle some volatility.
Moderate Tax-Efficient Saver Portfolio
Time Horizon Until Retirement: 20-Plus Years | Risk Tolerance/Capacity: Above Average | Target Stock/Bond Mix: 80/20
20%: Fidelity Intermediate Municipal Income
25%: Fidelity Spartan Global ex-US Index Advantage
55%: Fidelity Spartan Total Market Index Advantage
This portfolio is geared toward a slightly older investor, one who intends to retire in 2035. (Assuming a retirement at age 65, our hypothetical individual would be in his or her 40s today.) But the Moderate portfolio, like the Aggressive version, includes a large stock position and a still-sizable allocation to foreign names.
As with the Aggressive Saver mutual fund portfolio, I've used Morningstar's Lifetime Allocation Indexes to help set the baseline asset allocations. In this case, I used the Moderate version of the 2035 index.
Conservative Tax-Efficient Saver Portfolio
Time Horizon Until Retirement: 10 Years or Fewer | Risk Tolerance/Capacity: Low | Target Stock/Bond Mix: 65/35
15%: Fidelity Limited Term Municipal Income
20%: Fidelity Intermediate Municipal Income
15%: Fidelity Spartan Global ex-US Index Advantage
50%: Fidelity Spartan Total Market Index Advantage
Because the bond piece of this portfolio is larger than is the case with the Moderate portfolio, it's also more diversified. While younger accumulators can get away with a single well-diversified bond fund--in this case, Fidelity Intermediate Municipal Income--people closing in on retirement will want to start diversifying their fixed-income exposure. Thus, I added a position in a short-term bond fund. With retirement 10 years into the future, it's too early to start raising cash for in-retirement living expenses; at today's very low yields, the opportunity cost of doing so is simply too great. But pre-retirees might consider steering part of their fixed-income sleeves to a short-term bond fund that could be readily converted into cash. After all, having sufficient short-term assets in the portfolio can help mitigate sequencing risk--the chance that a retiree could encounter a lousy market right out of the box.