Last month, The Wall Street Journal said Fidelity was banning U.S. investors overseas from buying its mutual funds. Is it a blessing in disguise?
Fidelity does sell indexes. But the firm is best known for its actively managed products. No, there’s nothing wrong with Fidelity’s funds. They’re known for their strong performance and low costs. But when expats buy them taxes can whack them.
Index funds usually earn higher returns for two reasons. They cost less. And they’re far more tax-efficient—especially for expats.
Here’s why. Overseas Americans can’t invest in an IRA if they earn less than a predetermined amount. In 2013, it was $97,600 per year. The IRS Foreign Earned Income Exclusion says U.S. expats don’t have to pay income taxes to Uncle Sam when they earn less than this amount. It protects them from getting taxed twice: once in the U.S. and a second time in their adopted country.
Those not paying U.S. income taxes can’t invest in a tax-sheltered IRA. So when their investments make money they can attract taxes like mosquitoes to nudist camps. Actively managed funds are actively traded. Investors in taxable accounts pay taxes on each profitable trade. Stocks within an index fund aren't frequently traded. So they generate far less tax.
For example, Fidelity’s Capital Appreciation Fund is actively managed. It earned 25.57 percent during the 12 months ending July 25, 2014. Morningstar estimates its after-tax performance was 21.64 percent. Schwab’s U.S. Large Cap ETF tracks an index of large American stocks. Its 12-month return was 24.77 percent. So Fidelity’s actively managed fund beat it. But the after tax story is the one that counts. Morningstar says investors would have earned 23.77 percent.
July 25, 2013 to July 25, 2014
|Fidelity Capital Appreciation Fund (actively managed)||Schwab U.S. Large Cap ETF (indexed)|
|Before Tax Return||+25.57%||+24.77%|
|After Tax Return||+21.64%||+23.77%|
But what about higher-income expats? In 2013, investors below the age of 50 could invest $5,500 per year in an IRA. Those that are older could invest $6,500. Many people, however, want to invest much more. For the surplus, they usually have to settle for taxable accounts. In such cases, when they buy actively managed funds, Uncle Sam scalps them.
In 2009 Mark Kritzman’s 20-year study was reported in the New York Times. He compared after-tax performances for index and actively managed funds. Investors in the highest tax bracket would have to beat an index by 4.3 percent a year before fees and taxes, just to match the benchmark’s performance.
Americans that are banned from Fidelity don’t need to worry. Do-it-yourself investors can build portfolios with Schwab’s ETFs. Or investors can choose from firms willing to do it for them.
Some offer full financial planning. Others don’t. This isn’t an exhaustive list. But it’s a good place to start looking.
Firms That Will Build Index Portfolios For Overseas Americans
|Advisory Firm||Servicing||Maximum ManagementCosts||Minimum Account Size||Includes Full Service Financial Planning||Will Rebalance Portfolios of Indexes||Contact Information|
|Noto Financial Planning||Americans||1%||$150,000||Yes||Yes||
Tel#: 1 (808) 638 2475
|Creveling & Creveling||Americans||1.2%||$750,000||Yes||Yes||
Tel. #: (66) 2661 2716
|MASECO||Americans Based in Great Britain||1.25%||$1,000,000||Yes||Yes||
Tel. #: (44) 207 043 0455
|Index Fund Advisors||Americans||0.9%||$100,000||Yes||Yes||
Tel#: 1 (949) 502 0050
|RW Investment Strategies||Americans||0.4%||No minimum||No||Yes||
Tel#: 1 (443) 896 4123
Tel#: 1 (972) 535 4040
|Raymond James Financial||American School teachers only||1%||$20,000||No (1)||Yes||
Tel#: 1 (703) 406-8440
|(1) Index investors wanting full financial planning with Raymond James Financial must pay additional fees for the service|