Fidelity’s Free Mutual Funds and the Resulting Fidelity Mania
Issue: January/February 2019
Author: Joel M. Schofer, MD MBA CPE FAAEM
Commander, Medical Corps, U.S. Navy
If you read financial blogs or follow the financial news, you probably read multiple articles about Fidelity’s latest offensive in the investment company price war — free index mutual funds. Yes ... completely free with a 0% expense ratio. What does this mean for the average investor? Let’s take a look...
About a year ago I wrote about how all of the major investment companies — Fidelity, Schwab, and Vanguard — were competing for your business by lowering their investment fees. Vanguard has been the lowcost leader and used that focus and their unique non-profit structure to become the largest investment company, managing over $5 trillion. For comparison, Fidelity oversees $2.5 trillion. Yes, TRILLION.
Vanguard’s mantra emphasizes the following central tenets of investing:
- The lower your investment fees, the more of the investment return you get to keep.
- Costs last forever.
- You should invest with low cost, broadly diversified index funds.
As you might have guessed, this is what I do. I do this at Vanguard and with my military retirement plan accounts.
In July, Fidelity announced that they were offering two new mutual funds at no cost — free — to investors with no investment minimums. The funds are the:
- Fidelity ZERO Total Market Index Fund (FZROX) — a diversified US stock index fund
- Fidelity ZERO International Index Fund (FZILX) — a diversified international stock index fund
Everyone was waiting for one of these investment giants to offer free mutual funds. Fidelity became the first. Eventually someone will offer a fund that PAYS people to invest in it, but we’re not there yet.
Ever since this announcement, there have been countless news articles and blog posts about the free funds. I guess I’m now contributing to that. People have been clamoring to switch to Fidelity funds, but a closer look will show you that switching to Fidelity is not guaranteed to be a good move or even what most people trying to minimize their fees should do.
They’re Free! Why Not Switch?
First, Fidelity is not a stupid company. There is no such thing as a free lunch, and they are going to make money from their customers somehow. One way would be by luring you to Fidelity for these free funds, but charging you more on other investments. As the author of this article on Morningstar stated:
“But, ultimately, no companies toil for free. What they give away in one place, they recoup in another.”1
They’ll make up the difference with other funds or brokerage services.
In addition, “The White Coat Investor” wrote one heck of an article that deep dives on expense ratios and the new Fidelity funds. In it he points out that when you look at equivalent Vanguard, Schwab, and Fidelity funds you’ll see that Vanguard seems to win even with slightly higher expenses and they have a tax efficiency advantage that Schwab and Fidelity don’t have. As he notes:
“It just turns out that Vanguard is better at indexing than Fidelity and Schwab. Is that really a surprise to anyone?”2
I hate to reinvent the wheel, so those interested in the details should really read his article: www.whitecoatinvestor.com/expense-ratios/.
What Does This Mean for Investors?
If you are already a Fidelity investor, their drive to compete with Vanguard is going to give you some really useful low-cost investment opportunities.
If you are not already a Fidelity investor, realize that if you sell any investments in a regular taxable account (outside of a tax advantaged retirement account like a 401k or IRA), you will have to pay taxes on any capital gains you have. Unless selling won’t generate any taxes (you don’t have any gains) or what you are invested in is an extremely poor choice, I wouldn’t give Uncle Sam some of your money just to save a few hundredths of a percentage point on your expense ratio.
Here’s a good quote from another Morningstar article about the new Fidelity funds that demonstrates how little of a difference these small percentages can have on your bottom line:
“To illustrate the modest stakes for your portfolio, let’s look at the growth of a $10,000 investment in Fidelity Total Market Index (FSTVX), Schwab Total Stock Market Index (SWTSX), and Vanguard
Total Stock Market Index (VTSAX). Over the years, the three have changed leadership on fees, and investment minimums have changed, too. For the past 10 years, $10,000 in Vanguard Total Stock
Market Index would have grown to $28,520, while the Schwab fund would have grown to $28,460 and the Fidelity fund to $28,350. And the differences at times were greater than they are today. So, keep costs low and save as best you can, but don’t worry too much about a couple of basis points.”3
In addition, you can’t underestimate the benefit of simplicity when it comes to your investment portfolio. I had the military retirement accounts and Vanguard. That was it. Then my wife changed employers and now we have an expensive 401k with John Hancock that drives me nuts.
While I keep track of everything with Personal Capital and that makes it pretty easy, having yet another website (John Hancock) I have to login to when I want to make changes is kind of a pain. Don’t underestimate the peace of mind that comes with simplicity, and adding Fidelity to the mix for a few basis points might not be worth the hassle.
If you are just starting out as an investor, just realize that you really can’t go wrong with Fidelity, Schwab, or Vanguard as long as you focus on their low cost funds. At Vanguard, all the funds are low cost, so that simplifies your investing life, but Schwab and Fidelity are fine as well.
What’s the Bottom Line?
- If you’re already invested with Fidelity, enjoy the new free funds and use them for your US and international stock investments.
- If you haven’t picked an investment company yet, Fidelity is certainly one to consider but I’d still go with Vanguard if it was up to me.
- You probably should not switch from another company just for free funds, and certainly should not sell anything that would trigger a capital gain just to switch.
The White Coat Investor summarized the strategy you’d employ no matter what company you pick in his article about the Fidelity funds:
“There is no new investing strategy going on here. It’s the same old, same old investing strategy – buy all the stocks, hold them, keep your costs and taxes down, and in the long run, your money grows at the same rate as the market and if you save enough, you become financially independent.”4
The views expressed in this article are those of the author and do not necessarily reflect the official policy or position of the Department of the Navy, Department of Defense or the United States Government.