End of year analysis of Fidelity FidFolio (Direct Indexing S&P 500) performance and tax benefits

[jcloudm]

Back in April, I decided to put some money into a Fidelity FidFolio US Large Company Index account. This is a direct indexing account, so instead of holding an ETF or Mutual Fund it actually holds the components of the index directly, using fractional shares.

I put money into the account on April 6th, 2022. On that date, IVV (the iShares ETF that represents the S&P 500) had a NAV of 448.49. As I wrote this on the 29th, the NAV of IVV was 385.39, down 14.07%. The FidFolio account at this exact moment, net of the 0.4% management fee, is down 13.88%. I consider this effectively the same, although note that the FidFolio account is slightly better.

During this period, the algorithms behind the account also harvested 21.9% of the original funded value of the account in capital losses. This in my mind is the real benefit of this account - with zero effort from me they harvested significantly larger losses than I would have been able to if I were just doing end of year tax loss harvesting. This allows me to offset other gains I have, and in my case actually reduce this year's tax bill.

In my opinion, if you have a taxable account and you are in a tax bracket for which avoiding capital gains and tax loss harvesting is relevant, this is a great option and it more than makes up for the management fee. Note that they only have a S&P 500 option at this time, not a full US option. This works for me since my 401k funds also split into S&P 500 and "rest of market" so I have to manage the US as two separate allocations already.

This won't be relevant for everyone but if you have a significant taxable account portfolio and are interested, I'm happy to answer any questions.

[Jacotus]

Before I tried it, manual tax loss harvesting was a little intimidating (even more so before companies were forced by law to keep track of basis). But I would never pay a 0.4% management fee just to get tax loss harvesting. On a $1 million portfolio, you'd be paying $4,000/year, whereas the annual deduction of $3,000/year on income might save you only ~$1,000/year.

TLH is quite simple as you only have to take action once every few years to obtain the vast majority of the benefit. Bogleheads, IMO, can save themselves the 0.4% and do it themselves.

[mmse]

In my opinion, if you have a taxable account and you are in a tax bracket for which avoiding capital gains and tax loss harvesting is relevant, this is a great option and it more than makes up for the management fee.

Thanks for the offer. How long is the 1099-B and Schedule D (in transactions and pages)?

[jcloudm]

Before I tried it, manual tax loss harvesting was a little intimidating (even more so before companies were forced by law to keep track of basis). But I would never pay a 0.4% management fee just to get tax loss harvesting. On a $1 million portfolio, you'd be paying $4,000/year, whereas the annual deduction of $3,000/year on income might save you only ~$1,000/year.

TLH is quite simple as you only have to take action once every few years to obtain the vast majority of the benefit. Bogleheads, IMO, can save themselves the 0.4% and do it themselves.

Certainly do it yourself works! But if the whole index keeps increasing you may never have the opportunity to TLH for years at a time. That's the advantage of direct indexing - you can take advantage of the parts of the index that are down substantially even when the whole index is up. This year proved that this product harvested a fair amount more than just harvesting the ETF would have, unless you timed the harvest to exactly when the ETF was at its lowest.

For my situation I have significant other capital gains that I can offset well more than $3K a year. There are other cons - length of statements and number of tax transactions. I agree it's not for everyone. But I would argue there are certainly Bogleheads for whom this might work well and be financially beneficial.

[mervinj7]

For my situation I have significant other capital gains that I can offset well more than $3K a year. There are other cons - length of statements and number of tax transactions. I agree it's not for everyone. But I would argue there are certainly Bogleheads for whom this might work well and be financially beneficial.

Have you used tax software to import the transactions yet?

[jcloudm]

In my opinion, if you have a taxable account and you are in a tax bracket for which avoiding capital gains and tax loss harvesting is relevant, this is a great option and it more than makes up for the management fee.

Thanks for the offer. How long is the 1099-B and Schedule D (in transactions and pages)?

I don't have the number of pages yet, but I would say there are so many transactions that unless you import your taxes from Fidelity into a TurboTax-like product, it is unwieldy to enter manually. There were 985 sale transactions in 9 months.

[Jacotus]

Certainly do it yourself works! But if the whole index keeps increasing you may never have the opportunity to TLH for years at a time. That's the advantage of direct indexing - you can take advantage of the parts of the index that are down substantially even when the whole index is up. This year proved that this product harvested a fair amount more than just harvesting the ETF would have, unless you timed the harvest to exactly when the ETF was at its lowest.

That's true, I forgot to account for being able to TLH the individual components even if the index as a whole increases.

From previous discussions on this style of direct indexing at TLH, I seem to recall mention of possibility of becoming stuck overweight in certain stocks, but I am not up on the details.

[jcloudm]

Have you used tax software to import the transactions yet?

No, Fidelity usually doesn't get me my 1099's until mid to late February. I can report back here when it happens.

[livesoft]

Certainly do it yourself works! But if the whole index keeps increasing you may never have the opportunity to TLH for years at a time. That's the advantage of direct indexing - you can take advantage of the parts of the index that are down substantially even when the whole index is up. This year proved that this product harvested a fair amount more than just harvesting the ETF would have, unless you timed the harvest to exactly when the ETF was at its lowest.

FWIW, we have a 7-figure taxable investment account, but since we are retired we no longer contribute to it. Despite the 2022 performances of stocks we had no positions that we could have tax-loss harvested in 2022. More plainly: All our positions still had gains every single day of 2022.

Of course, if we had started Direct Indexing in 2022, then we would have had to realize lots of capital gains by selling existing positions in order to set up a portfolio of individual stock positions. And THEN we would have been able to do some tax-loss harvesting.

So a question for @jcloudm: Did you have to sell existing positions to get going? Or when you wrote "put some money" you meant you started with cash on-hand to get going?

[jcloudm]

FWIW, we have a 7-figure taxable investment account, but since we are retired we no longer contribute to it. Despite the 2022 performances of stocks we had no positions that we could have tax-loss harvested in 2022. More plainly: All our positions still had gains every single day of 2022.

Of course, if we had started Direct Indexing in 2022, then we would have had to realize lots of capital gains by selling existing positions in order to set up a portfolio of individual stock positions. And THEN we would have been able to do some tax-loss harvesting.

So a question for @jcloudm: Did you have to sell existing positions to get going? Or when you wrote "put some money" you meant you started with cash on-hand to get going?

I have a similar problem - almost nothing that I could have sold without a gain, especially in this asset class. I just happened to have some cash on hand from dividends that I decided to invest here instead of just buying another fund.

I would absolutely agree with your approach and would not realize capital gains to do this; it's not beneficial enough to offset large past gains. In the future, if this harvests more losses than I can deduct with the $3K limit, I'll probably offset those gains by selling S&P 500 mutual fund shares that I've had for decades and moving those dollars here.

[rkhusky]

What was the dividend rate? And it would be interesting to see the qualified dividend rate once that is released.

[jcloudm]

I also forgot to add another benefit. I work for an S&P 500 company, and as such have a sizable position in that stock due to expected future RSUs. I was able to exclude that stock from this account; you can exclude up to 5 tickers.

[jcloudm]

What was the dividend rate? And it would be interesting to see the qualified dividend rate once that is released.

Dividend rate was 1% from my initial investment over 9 months. I believe IVV over the same period was about 1.1%, so a slight deficiency there.

I'll report back with the qualified dividend rate.

[rkhusky]

What was the dividend rate? And it would be interesting to see the qualified dividend rate once that is released.

Dividend rate was 1% from my initial investment over 9 months. I believe IVV over the same period was about 1.1%, so a slight deficiency there.

I'll report back with the qualified dividend rate.

Actually, lower dividend and higher QD rate is more tax efficient. But you really want to maximize after-tax return.

[jcloudm]

Actually, lower dividend and higher QD rate is more tax efficient. But you really want to maximize after-tax return.

I guess it's possible that reduced dividend rate explains the mildly better performance of the account, but that would probably take multiple years to be sure.

[rkhusky]

Actually, lower dividend and higher QD rate is more tax efficient. But you really want to maximize after-tax return.

I guess it's possible that reduced dividend rate explains the mildly better performance of the account, but that would probably take multiple years to be sure.

Stock dividends have no effect on before-tax performance, since the stock price drops the same amount as the dividend. (If you just compare NAV changes, you are neglecting dividends.). Dividends and QD rate do affect after-tax performance.

[Fclevz]

In my opinion, if you have a taxable account and you are in a tax bracket for which avoiding capital gains and tax loss harvesting is relevant, this is a great option and it more than makes up for the management fee.

Thanks for the offer. How long is the 1099-B and Schedule D (in transactions and pages)?

I don't have the number of pages yet, but I would say there are so many transactions that unless you import your taxes from Fidelity into a TurboTax-like product, it is unwieldy to enter manually. There were 985 sale transactions in 9 months.

Unless there are adjustments (like a wash sale), you don’t need to enter every transaction on your tax form, only the total amounts.

[Gaston]

Before I tried it, manual tax loss harvesting was a little intimidating (even more so before companies were forced by law to keep track of basis). But I would never pay a 0.4% management fee just to get tax loss harvesting. On a $1 million portfolio, you'd be paying $4,000/year, whereas the annual deduction of $3,000/year on income might save you only ~$1,000/year.

I get your point, but I assume that people who sign up for Direct Indexing do so in order to offset capital gains elsewhere (or to exclude a stock from the index that they hold elsewhere). If they do it only to deduct $3000 from ordinary income, then I agree it seems hardly worth the cost.

I’d also like to know how one terminates a Direct Indexing agreement, without incurring a large tax bill or being left with several hundred stocks that you now have to manage manually. Anyone know how that works?

[Gaston]

Back in April, I decided to put some money into a Fidelity FidFolio US Large Company Index account. This is a direct indexing account, so instead of holding an ETF or Mutual Fund it actually holds the components of the index directly, using fractional shares.

Thank you for submitting this. I do not plan to use Direct Indexing, but it still is interesting to learn how it works.

[Startled Cat]

I put money into the account on April 6th, 2022. On that date, IVV (the iShares ETF that represents the S&P 500) had a NAV of 448.49. As I wrote this on the 29th, the NAV of IVV was 385.39, down 14.07%. The FidFolio account at this exact moment, net of the 0.4% management fee, is down 13.88%. I consider this effectively the same, although note that the FidFolio account is slightly better.

Does the value of the FidFolio account include any reinvested dividends? If so, it's not a fair comparison with an ETF's NAV.

[asset_chaos]

Back in April, I decided to put some money into a Fidelity FidFolio US Large Company Index account. This is a direct indexing account, so instead of holding an ETF or Mutual Fund it actually holds the components of the index directly, using fractional shares.

...

During this period, the algorithms behind the account also harvested 21.9% of the original funded value of the account in capital losses. This in my mind is the real benefit of this account - with zero effort from me they harvested significantly larger losses than I would have been able to if I were just doing end of year tax loss harvesting. This allows me to offset other gains I have, and in my case actually reduce this year's tax bill.

...

This won't be relevant for everyone but if you have a significant taxable account portfolio and are interested, I'm happy to answer any questions.

What happens to the harvested cash? The algorithm sells a stock lot to harvest a loss and presumably recieves cash from the sale. Does the cash sit in a money market for 30 days, then buys back the original position; does the cash immediately buy a different stock (or set of stocks) that were loss harvested more than 30 days previously; or, something else?

My thanks also for reporting the experiment.

[BF3000]

Immediate swap of stock positions. I attended Schwab’s presentation of their large cap, small cap, and international offerings. The large cap seeks to track the Schwab 1000 index. It starts with about 600 or so positions that will track the index well enough. 400 highly correlated positions are left on deck for immediate swapping if a TLH opportunity arises.

[Jacotus]

Before I tried it, manual tax loss harvesting was a little intimidating (even more so before companies were forced by law to keep track of basis). But I would never pay a 0.4% management fee just to get tax loss harvesting. On a $1 million portfolio, you'd be paying $4,000/year, whereas the annual deduction of $3,000/year on income might save you only ~$1,000/year.

I get your point, but I assume that people who sign up for Direct Indexing do so in order to offset capital gains elsewhere (or to exclude a stock from the index that they hold elsewhere). If they do it only to deduct $3000 from ordinary income, then I agree it seems hardly worth the cost.

I'm sorry, I figured it was clear that if you TLH manually, you can still offset capital gains elsewhere. My point was just to quantify what can be immediately quantified.

Again, my estimate is one can obtain the vast majority of available losses by harvesting manually, say, once a year.

[jcloudm]

What happens to the harvested cash? The algorithm sells a stock lot to harvest a loss and presumably recieves cash from the sale. Does the cash sit in a money market for 30 days, then buys back the original position; does the cash immediately buy a different stock (or set of stocks) that were loss harvested more than 30 days previously; or, something else?

My thanks also for reporting the experiment.

The cash buys a different set of stocks. It's investing in about half of the S&P 500 so it has half sitting around that it can swap in when harvesting.

[jcloudm]

Again, my estimate is one can obtain the vast majority of available losses by harvesting manually, say, once a year.

This year may be an outlier, but I wouldn't necessarily call end of year harvesting the "vast majority". If I had harvested at end of year I would have harvested 14% of a loss, but direct indexing added on another 8% of my original investing. If you had timed the down market perfectly you maybe would have achieved the same outcome with ETF harvesting, but far be it from me to guess when I can harvest an ETF loss when an algorithm can do it for me.

[growthbogle]

Is this any different from their SMA offering? I have an international tax advantage SMA which post-tax did well due to TLH that I could use to offset other capital gains.

[alex_686]

I’d also like to know how one terminates a Direct Indexing agreement, without incurring a large tax bill or being left with several hundred stocks that you now have to manage manually. Anyone know how that works?

Exactly the same way one terminates (or withdraws cash from) from a index fund. You sell it.

Expect you should have fewer built in unrealized long term gains and have a touch more flexibility. The above concern is not a good reason to avoid direct indexing. You are even more locked into the index fund you chose at inception.

I am a modest proponent of direct investing. I was involved with it a long time ago. Not sure if it is ready for the mass market. It is more complex but it is the type of complexity that computers handle well. But there are many other moving parts. Higher risk due to higher complexity, higher costs, uncertain tax benift.

[jcloudm]

Is this any different from their SMA offering? I have an international tax advantage SMA which post-tax did well due to TLH that I could use to offset other capital gains.

I think it's effectively the same product as the index SMA offerings, but you don't get an advisor with it - it's all online. It starts at lower minimums as well. They have one that tracks US Large Cap and one that tracks ex-US developed Large/mid Cap. I believe the indexes used are the same between Fidfolio and SMA.

[Thoughtf$l]

Thank you, #jcloudm!
Fidelity advisor recommended FidFolio for three kids (young adults) who will be holding onto this investment for some years.
- like the concept of TLH since they won’t do it themselves.
- however …. They are in a low tax bracket already. Will change as they get real jobs.
- wish there were more info on WHO is guiding the portfolio and when the purchases are timed. There is a lot of wiggle room in the price of each component in a day.
- trying to weigh the .4% fee vs no load VTI. And also making it easy since kids are going to leave it there.
- has been super hard for even my fidelity advisor to find a human to speak with at FidFolio. Not sure how they are actually making their purchase/sell decisions. It is a group which told him this is “new” and they are sorting it out. I was hoping it would be the experienced SMA team.
- does advisor also profit on the referral? I’ve asked her/him too. Will let you know the answer.

Again - thank you! The only real discussion I could find in line. I am a thoughtf$ul person and scientist but not an experienced investor nor a wealthy person myself.

[kxl19]

After reading the OPs comments and doing some research on Fidelity, I’m setting up a call to get more details.

As I learn more will report back. Might be an interesting product for those that are…

High tax bracket
Already doing periodic investments into an index
Also have ongoing capital gains (Ie like from employee stock)
Don’t have near-term plans for funds

[kxl19]

jcloudm - with direct indexing, I suppose there were many trades.

How difficult was it to enter the 1099 from Fido? Could it be automatically brought into your tax software?

[Hydromod]

The tax-loss harvesting aspect is consistent with some of my back test calculations with a portfolio of perhaps 15 3x LETFs. Even though the algorithm adjusts allocations weekly to maintain a desired risk profile, after the first year or two there seems to be enough harvesting accumulated that the overall tax bill is zero in most subsequent years. If I'm doing the calculations correctly, this is more effective for 3x than for the same strategy using 1x ETFs.

It seems like every few years there is a year where a bank of losses is accumulated, which can be used in subsequent years.

[jcloudm]

jcloudm - with direct indexing, I suppose there were many trades.

How difficult was it to enter the 1099 from Fido? Could it be automatically brought into your tax software?

There were a ton of trades! My 1099 for this account alone was 138 pages.

It all imported perfectly into TurboTax, although it gave me a warning that it could be slow to do the import given the size.