Investing Assets & Markets Mutual Funds Best Fidelity Funds to Keep Taxes Low These Fidelity Mutual Funds Can Minimize Your Tax Bill By Kent Thune Updated on July 27, 2021 Reviewed by Anthony Battle See some of the best Fidelity funds to buy to minimize taxes. Photo: iStockphoto One mistake newer investors make with mutual funds is that they forget to manage and reduce the costs of their funds. This can even happen for those with more experience. Minimizing expenses with mutual funds is no different than minimizing expenses when managing your finances. This is also known as managing your cash flow. Reducing your expenses (cash outflow) is just as beneficial as increasing your revenue (cash inflow). And minimizing taxes in a taxable account has the effect of keeping your expenses low. This increases your net returns. You can think of this in another way: If you're paying more than necessary in taxes, you take home less money. This means you've reduced the return on your investment. Learn how mutual funds are taxed and become familiar with some actions you can take to lower taxes; this is important if you have investments. Minimizing your taxes will help you get the most from your investments. Key Takeaways You'll pay taxes on capital gains, dividends, and bond funds; each is taxed in different ways.Fidelity is one of the larger investment management companies. It has mutual funds that can keep taxes low in your taxable brokerage account.You can look at certain key statistics, such as the tax-cost ratio, to predict the tax efficiency of a given fund.Building a portfolio suited for your needs should be your first priority. Then you should look at making it as tax efficient as you can. How Are Your Mutual Funds Taxed? Each time you earn money for something you haven't paid taxes on before, the government is going to want its share. One method of taking taxes from investors receiving distributions: the capital gains distributions tax. Stock mutual funds may invest in hundreds of stocks. During any given tax year, the manager of the fund will buy and sell several of the stock holdings in the portfolio. Capital Gains Taxes When the manager sells stocks that have gained in value since the time they bought those stocks, the trades generate capital gains (money earned). These are then passed along to the investor in the form of capital gains distributions. Capital gains are taxed differently than dividends. Capital gains are taxed as normal income; dividends are taxed at a higher rate. For this reason, distribution funds with low turnovers, such as index funds, can be more tax-efficient than actively managed funds. Note Mutual fund turnover occurs when managers sell shares in the fund and replace them with other shares. Dividend Taxes Another common form of taxation coming from mutual funds is generated by dividends. Dividends are taxed as normal income; this is true unless it meets qualified requirements. These are dividends from domestic corporations and qualified foreign corporations. If you want to reduce taxes, you'll want to avoid high-yielding mutual funds. These could include large-capacity (large-cap, or companies with large market capitalization) value stock funds. Fund types that pay little to no dividends include small-cap stock funds and growth stock funds. Bond Fund Taxes Bond mutual funds are the type that you'll need to look into the most when it comes to lowering taxes. To keep taxes to a minimum with bond funds, the best type to buy are municipal bond funds. Note Municipal bonds are issued by state and local governments and other municipalities. This type of mutual fund buys municipal bonds. To incentivize government investment, these bonds are free of federal income tax. If you live within the state or municipality that issues the bond, income may also be tax-free on that level. What Are the Best Fidelity Funds to Reduce Taxes? Fidelity is one of the larger investment management companies. It has a number of mutual funds that can keep taxes low in your taxable brokerage account. Note Lower fees and less turnover are other methods you can use to reduce taxes. Fidelity Small Cap Enhanced Index (FCPEX) This index fund focuses on small-cap stocks. In most cases, these pay fewer dividends when compared to large-cap stocks. For instance, the average large-cap stock fund could have a yield of at least 2% or more; FCPEX will often average less than half that. Low yields will help keep income taxes low. FCEPX has historically beaten more than 90% of other small-cap funds for tax-adjusted returns. The expense ratio is low for a small-cap fund at 0.64%. There is no minimum initial investment. Fidelity International Discovery Fund (FIGRX) This is a foreign stock fund that primarily invests in stocks of non-U.S. companies. Foreign stock funds are not commonly tax-efficient. But FIGRX has a track record of better than average tax efficiency and above-average returns as well. These combine to make FIGRX a smart choice for those who need a foreign stock fund in a taxable account. The expense ratio for FIGRX is below average at .78%. There is no minimum initial investment. Fidelity Tax-Free Bond (FTABX) FTABX holds municipal bonds that are exempt from federal income tax. Most of the holdings are bonds issued by state and city governments in the U.S. Municipal bonds often offer lower yields than other bonds. The tax-free status can produce a tax-effective yield that can beat other bonds. Note Often, those who are in higher tax brackets benefit the most from holding municipal bond funds like these. The expense ratio is 0.25%; the minimum initial investment is $25,000. Fidelity also offers tax-free municipal bond funds that focus on states, such as California, New York, and Massachusetts. Those living within these states may choose to use these funds to take advantage of state tax benefits. Fidelity Tax-Exempt Money Market (FMOXX) A money market fund can be a smart choice for those wanting liquid fundholding for short-term cash. Similar to the tax-free bond funds, FMOXX will be best for people in higher tax brackets. FMOXX has an expense ratio of .45%. There is no minimum initial investment. How Can You Find Your Own Tax-Efficient Funds? If there are other fund types you need for your taxable account, you can look at certain key statistics to predict the tax efficiency of the fund. One is the tax-cost ratio. This is a measure of how much investors lost due to taxes. For instance, let's say a mutual fund had a 5-year annualized return of 10%, and the tax-cost ratio was 1%. The after-tax return would have been 9%. Some online market and investing websites, such as Morningstar, Inc., offer information on tax-cost ratios and other key indicators such as tax-adjusted returns. For instance, at Morningstar.com, you can search for a mutual fund's ticker symbol. Then, you can learn about the fund you are researching. Note Another way to lower expenses: buy funds with no load (or no upfront costs) with low expense ratios. Once you find the fund's listing on the site, look for the tab that says "Tax" and click on it. That page will display key tax data points; this could include tax-cost ratio and tax-adjusted returns. You can compare these with other funds. Then, choose the one that is best for you and your needs. Above all, remember to prioritize smart investing practices, such as diversification, risk tolerance, and fund selection based upon your objectives. Don't just look at tax efficiency alone. Building a portfolio suited for your needs should be your first priority. Then you should look at making it as tax efficient as you can. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Internal Revenue Service. "Instructions for Form 1099-DIV (2021)." Fidelity. "Fidelity Small Cap Enhanced Index Fund." Fidelity. "Fidelity International Discovery Fund." Fidelity. "Fidelity Tax-Free Bond Fund." Fidelity. "Fidelity Tax-Exempt Money Market Fund."