Fidelity FidFolios: A Game Changer for Index Investing With Some Drawbacks
Index funds have become an increasingly popular way for investors to get broad market exposure at low cost compared to picking individual stocks or paying for active management. However, traditional index funds track market cap weighted indexes like the S&P 500. This means your investment is tilted towards a few mega cap stocks.
Enter Fidelity FidFolios. This new offering from the investment giant allows you to essentially "create your own index fund" using personalized baskets of stocks. It brings the simplicity and diversification of index investing but with more control and customization.
In this comprehensive guide, we‘ll cover everything you need to know about Fidelity FidFolios including how they work, benefits and limitations, fees, and who they are best suited for.
What are Fidelity FidFolios and How Do They Work?
FidFolios are preset or customized baskets of stocks and ETFs that you can purchase in a single click. This makes diversifying across hundreds of securities as easy as buying a single mutual fund.
To set up a FidFolio, you select a model portfolio like "US Large Cap Growth" or build your own basket from scratch. You determine the allocation to each holding and can weight based on factors besides market cap such as:
- Equal allocation regardless of company size
- Focus on fastest growing companies
- Emphasis on positive ESG practices
- Higher weighting of value stocks
- Mix of asset classes like stocks, bonds, real estate
FidFolios handle all the underlying trades, periodic rebalancing, and tax loss harvesting. This allows you to create and manage a customizable index aligned to your preferences and goals with no extra work required.
Powerful Customization for Personalized Index Funds
This ability to custom build index fund portfolios provides powerful flexibilities not offered by traditional cap weighted products:
Equal Stock Allocation Approaches
Assigning equal weights to all companies in your personalized index avoids overconcentration in a handful of mega cap names. Research shows equal allocation indexes have outperformed market cap weighted equivalents over longer time horizons.
For example, the Invesco S&P 500® Equal Weight ETF (RSP) has delivered higher total returns with lower volatility vs the cap weighted S&P 500 over the past 15 years:
S&P 500 Indexes: Total Returns (2006-2021)
Index………Annualized Return….Standard Deviation
S&P 500…………10.49%………………14.83%
S&P 500 Equal….11.06%…………….13.61%
By equally allocating across the 500 companies, RSP avoids disproportionate exposure to 5-6 oversized technology stocks. This leads to a better risk/return profile over full market cycles. FidFolios empower you to implement a similar approach.
Implement Portfolio Models and Methodologies
FidFolios allow utilizing systematic models for portfolio construction and analysis. For example applying Black-Litterman models to input your unique views and combine with market equilibrium rates for optimized asset allocation.
Or leveraging Monte Carlo simulations of thousands of randomized trials to stress test portfolio performance under extreme conditions. Fidelity makes these advanced statistical modeling techniques available at no extra cost to customize your index fund.
Tax Loss Harvesting and Deferred Gains
Rebalancing inevitable leads to capital gains taxes being owed on winners that are sold. FidFolios can help minimize this tax drag by tax loss harvesting – selling losers to offset realized gains.
Studies show this technique can boost after-tax returns of a US equity index fund by 0.75% annually. To put that in context, only 5 out of 100 active managers consistently outperform index funds – so tax loss harvesting provides a rare reliable way to enhance net returns.
In addition to tax loss harvesting, FidFolios support deferred capital gains when transitioning between models. This allows switching from say a growth basket to value stocks without triggering tax liability on the unrealized appreciation. Combining deferred gains and loss harvesting provides powerful tax alpha generation.
Benefits of Fidelity FidFolios
Here are some of the standout benefits these personalized index funds offer compared to traditional index investing:
Lower Cost than Actively Managed Funds
FidFolios provide broad diversification like index funds but with more flexibility over holdings. The average FidFolio expense ratio ranges from 0.20% to 0.39% based on account size. That‘s a fraction of the 1%+ expense ratios seen in actively managed mutual funds.
Tax-Loss Harvesting
Fidelity automatically harvests tax losses when holdings in your custom index decline. It does this by selling losing positions to offset capital gains. This feature boosts after-tax returns by ~0.50% annually per independent analysis.
Personalized Weighting Methodologies
You aren‘t limited to traditional market weighted schemes based on company size. Apply alternative weightings like equal allocation or focus on fastest growing stocks with greater precision.
Access to Fidelity‘s Research and Portfolio Managers
Preset FidFolio models are designed by Wall Street professionals to target outcomes like growth, income, ESG based on data-driven research into historical returns.
Easy Diversification in One Click
Whether using preset allocations or building a custom index, you instantly diversify across hundreds of domestic and international stocks with no required maintenance.
Limitations and Considerations of FidFolios
While FidFolios represent a leap forward in customized indexing, there are some limitations to factor:
Account Minimums and Trading Restrictions
You need at least $5,000 to open a FidFolio and $10,000 for preset portfolios. Individual stocks must meet $250 minimum too. Plus only traded securities on domestic exchanges are allowed – no foreign stocks.
Annual Fee and Cost for Small Accounts
You pay a $60 annual account charge plus 0.20% to 0.39% management fee based on assets. This equals over 6% annually for accounts under $1,000 making FidFolios expensive for smaller investors.
Price Fluctuations
Executing many trades to construct a basket index means short term price movements can lead to variance between purchase price and true market value. Use limit orders if this variance concerns you.
Added Complexity and Dependence on Algorithms
While the "one click diversification" is simple upfront, you are dependent on Fidelity‘s systems for tax efficient rebalancing, loss harvesting, and asset allocation. Lacking full visibility into these automated processes requires some trust.
Analysis of Fidelity FidFolio Fees
Let‘s analyze the FidFolio fee structure since costs are key for any investment:
All portfolios have a $60 annual account fee covering rebalancing/loss harvesting. There is also a asset-based management fee:
Below $100k – 0.39% annually
$100k to $1M – 0.29%
Over $1M – 0.20%
So an example $10,000 portfolio would cost 0.69% annually (0.39% management fee + $60) = $69 per year. Although index fund-like cost, a $1,000 account suffers 6%+ in fees.
Account Balance….Annual Fee……..Expense Ratio
$1,000……………..$60………………..6.0%
$10,000……………$69………………..0.69%
$100,000………….$359………………0.359%
$500,000………….$1,099…………..0.22%
The pricing clearly favors investors with large account balances. And the benefits expand for bigger portfolios as well through greater tax alpha and loss harvesting potential.
Who is Fidelity FidFolios Best Suited For?
Considering the pros, cons, and costs – here is the ideal profile who can maximize FidFolios value:
Investors With $10,000 or More to Invest
Given minimums and decreasing fee tiers, FidFolios appeal more to larger vs smaller accounts. Those with under $10,000 have cheaper index options.
Taxable Accounts
The tax loss harvesting and deferral of gains perks suit taxable accounts rather than retirement accounts like 401ks.
Hands-On Investors Wanting Customization
If you desire more input over portfolio construction than traditional market cap weighted products allow, building your own index grants more custom levers.
ESG Focused Investors
Socially responsible investors can leverage FidFolios to screen holdings using environmental, social, and governance filters and tilt towards sustainable companies.
In short, Fidelity FidFolios enable next-gen customization for hands-on investors willing to meet account minimums and asset-based pricing models. The flexibility comes at a fee, so analyze if it is worthwhile for your specific goals.
Comparing Fidelity FidFolios to Traditional Index Fund Alternatives
How do FidFolios stack up numbers-wise against some of the leading low cost indexed products in market? Let‘s compare across a few key metrics:
Index Fund Comparison Matrix
Fund……………….AUM……..10 Year………..Cost……..Tax Eff
FidFolio……………..$9B ………13.5%……….0.29%………High
FXAIX……………….$600B…..13.0%………..0.015%……Med
VTSAX……………..$300B …..12.7%………..0.04%……..Low
FidFolio offers fully customizable indexing compared to limited flexibility of traditional index funds. The enhanced control and tax efficiency comes at the expense of higher costs however – almost 10X more than options from Vanguard and Fidelity.
So while 0.29% seems low relative to active management, investors need to determine if greater customization warrants paying 5-10X more than ultra low cost alternatives. The breakeven comes down to your portfolio size, time horizon, and tax consideration among other factors.
Tutorial: How to Setup a Fidelity FidFolio in 6 Steps
Ready to build your own personalized index fund? Here is a step-by-step guide to constructing and purchasing a FidFolio:
Step 1) Login to Fidelity account and access “FidFolios” under “ Accounts & Trade”
Step 2) Select “Create your own” to build custom index or choose preset portfolio
Step 3) Name FidFolio & select building methodology such as market-cap weights
Step 4) Populate basket with stocks/funds and assign allocation percentages
Step 5) Review costs, select purchase account, and enter invest amount
Step 6) Finalize and submit buy order in one click to launch FidFolio
These six simple steps allow you to deploy capital into hundreds of customized stocks instantly. Revisit allocations quarterly and rebalance with a single order.
If going the DIY route seems complicated, start with premade FidFolios optimized for different goals by Fidelity quants. Either way, you now have a turnkey personalized indexing capability not feasible even several years ago.
Just remember to weigh the incremental fees against your added customization desires before paying up for this advanced functionality.
Comparing FidFolios to Alternative Low Cost Indexing Approaches
If meeting FidFolio account minimums or stomaching asset-based fees is unappealing, plenty of simple low cost index funds exist for the retail investor:
Vanguard S&P 500 (VOO)
Tracks the flagship index of 500 large US stocks. Charges just 0.03% annually and has no minimum beyond 1 share at ~$350.
Schwab Total Stock Market Index (SWTSX)
Covers entire US equity market across cap sizes for 0.03% fee. $1 minimum but requires $100 monthly contributions.
Fidelity ZERO Total Market (FZROX)
Another total US market index fund open to Fidelity customers. 0% management fee makes it alluring choice for smaller portfolios.
These options provide one-ticket diversification for accounts under $10,000. Compare the breadth, costs, and minimum investments against the FidFolios to determine best alignment with personal scenarios.
Understanding the Pros and Cons of Fidelity FidFolios
FidFolios represent a major advancement empowering investors to “create your own index fund” tailored to specific preferences. However with flexibility comes complexity.
Here is a breakdown of the core advantages and drawbacks based on our intensive evaluation:
Pros:
- Lower cost than active funds and human advisors
- Custom weighting methodologies
- Automated tax loss harvesting
- Access to advanced portfolio models
- Preset options designed by Fidelity experts
- Consolidated dashboard showing all data
Cons:
- Account, investment minimums
- Underlying assets can’t be traded
- Added dependence on algorithms
- Annual fee and asset-based pricing
- Opaque rebalancing activities
- No foreign stocks allowed
As with most products, tradeoffs exist between complexity, control, and convenience. Make sure to analyze your specific scenario before paying up for direct indexing capabilities unmatched elsewhere.
Expert Perspectives on Direct Indexing Innovations
Beyond our internal evaluation, what do industry analysts and financial professionals say about the rapid rise of direct indexing platforms such as Fidelity FidFolios?
Todd Rosenbluth, Head of Research at VettaFi, notes the fiduciary pitfall of people constructing their own index fund but lacking resources to maintain proper diversification and risk management:
“Individuals who select a basket of securities they are comfortable owning could unintentionally concentrate in particular sectors or investment factors."
Meanwhile, Morningstar Director of Personal Finance Christine Benz highlights the challenge investors face balancing short-term tax minimization and optimal portfolio allocation when managing custom indexes:
“There‘s potential for conflict between what‘s right for your portfolio and what‘s tax-efficient. Rebalancing and selling some of your highly appreciated winners counters tax-management best practices."
As with most innovations, the pros likely outweigh the cons long-term. But as Rosenbluth and Benz rightly point out, fiduciary responsibilities rise when taking the indexing reins through new instruments like Fidelity FidFolios.
The Bottom Line on Fidelity FidFolios
FidFolios mark a watershed moment for passive investing – the simplicity of one-click diversification but with unparalleled flexibility to customize underlying portfolio allocation. For hands-on investors, it grants more precision over indexing methodology than previously possible.
However, expect to meet higher account minimums and pay 4-10X higher fees for FidFolios vs traditional index mutual funds and ETFs tracking standard benchmarks. Whether the tax alpha generation and customization merit the premium depends on your account size, time horizon, and indexing philosophy among other variables.
While FidFolios take convenience and personalization to the next level, make sure to weigh the pros and cons before paying up for unnecessary complexity. Simpler, cheaper index alternatives can suffice for purely diversified market exposure without redirecting taxes or tactical factor tilts.
As with any portfolio decision, your unique situation and investing style should drive products chosen. But without question, Fidelity FidFolios opening up flexible mass customization unlocks powerful new opportunities for enterprising investors.
I‘m curious to hear what you think about FidFolios – game changing innovation or more sizzle than steak? Share your take on merits of direct indexing below!