Fidelity Investments recently launched four no-fee mutual funds to gain a competitive advantage against rivals Vanguard and Schwab. This move along with lowering existing index fund fees and eliminating minimum investment amounts go a long way to making investing easier and more affordable for investors.
This blog explains how you can take advantage of these developments to increase your investment returns.
Retail investing used to cost a lot of money that was hidden to mutual fund investors.
A mutual fund is a just a compilation of various company stocks or bonds (or both) that is professionally managed. Mutual funds can have different investment objectives – such as concentrating on fast growing stocks or dividend paying stocks. Others can just be a gauge or index of the entire market.
Actual results show that mutual funds that track market indices outperform actively managed mutual funds that have similar objectives. In an actively managed fund the manager tries to pick winners in the particular market segment.
Part of the reason that index funds perform better is that they don’t have high overhead expenses. Those managers need to be paid! Overhead expenses – expressed as an expense ratio – are higher for actively managed funds than for index or passively manage funds.
Vanguard has been the index fund leader by offering some mutual funds with expense ratios as low as 0.04%. The fee means that forty cents is deducted for every $1,000 invested.
Compare this fee to actively managed funds that have overhead expense ratios of 1.0% meaning that $100 is deducted for every $1,000 invested.
So it was a watershed moment when Fidelity recently introduced four mutual funds with zero overhead.
Fidelity also lowered the expense ratios on its line-up of 21 index funds that track other segments of the US and international stock and bond markets. These changes will make these Fidelity funds less or equally expensive than comparable ones offered by Schwab and Vanguard.
Indeed, Schwab had eliminated initial fund minimums and lowered fees in the last year as well. And both companies are trying to counter Vanguard’s lead in the index-field investing.
Fidelity’s Zero Fee Mutual Funds
Fidelity is offering no-fee versions of the index funds it already offers. In other words, the new no-fee funds are different products than the ones that have a low-fee. Fidelity could have eliminated the fees on its existing index funds, but I am guessing that would have cost too much money in lost revenue.
For example, the new Fidelity Zero Market Index (FZROX) tracks the performance of the entire US stock market. But Fidelity already offers a fund that tracks the same market – Fidelity Total Stock Market Fund Premium Shares (FSTVX).
But the new zero-fee version tracks a different index of the market. For example, the zero-fee version tracks the Fidelity US Total Investable Market Index where the fee-version (FSTVX) tracks the Dow Jones US Total Stock Market Index. The Fidelity US Total Investable Market Index has had a better track record (or higher return) than the Dow Jones US Total Stock Market Index. Over the last 5 years (as of September 28, 2018) the former has gained 13.40%/year where the later gained 11.25%. A rather sizable difference.
Fidelity is doing the same thing with its Fidelity Zero International Market Index (FZILX) that tracks a different index of the international market than its current International Index Fund (FTIPX).
Although the indices are different for comparable products only time will tell whether the mutual funds themselves will exactly track the index. Index funds generally hold at least 80% of the securities in the index and in roughly the same proportion as the index. But the fund’s performance may differ from the index given the realities of fund cash flow management. So it isn’t a given that just because one index is higher that the fund who tracks the index will be exactly like the index’s performance.
What Can You Do Now to Take Advantage of the Zero-Cost Funds?
1. You can’t get the no-fee versions unless you have a Fidelity account. You can’t, for example, buy these new funds using an E*Trade or another brokerage account. So if you want the no-fee versions, you’ll have to open a Fidelity account.
2. What if you have the fee version of the total stock market (FSTVX) or the international stock market (FTIPX), should you sell them and buy the no-fee versions? The answer is it depends.
If your account is a tax-deferred account (e.g., an IRA) then selling the fee version and buying the no-fee version won’t cause a taxable event. So that is probably a good idea.
But if you hold the fee versions in a taxable account then selling them would create a taxable event because you’d be selling one product (the fee version) and buying a new product (the no-fee version). Generally this isn’t such a great idea given the run up in the market recently.
I’m not sure which version of these funds – the fee version or the no-fee version – will do better. Only time will tell. But you can cut your fees by investing any new money in the no-fee version.