Vanguard, Fidelity, and Schwab have been engaging in a fierce competition to claim the mantle as the leading provider of low-cost index funds. As a result, each has aggressively lowered their fees for their index fund offerings over the past few years and advertised their low-cost offerings to investors.
After the latest round of fee reductions in mid-2017, I wrote a post speculating whether it was inevitable that Vanguard, Fidelity, or Schwab would offer a zero expense ratio mutual fund.
That’s right, an index fund that charges no management fee to its investors.
On August 3, 2018, Fidelity made the zero expense ratio index fund a reality, when they began offering the Fidelity ZERO Total Market Index Fund (FZROX), and the Fidelity ZERO International Index Fund (FZILX) to investors.
FZROX gives investors exposure to the total U.S. stock market (through the Fidelity U.S. Total Investable Market Index), while the FZILX tracks a global international stock index (the Fidelity Global ex U.S. Index).
These two funds will allow Fidelity investors to have exposure to the global stock market with zero fees.
Fidelity Announced More Than Just Two 0.00% Expense Ratio Index Funds
The announcement of zero expense ratio mutual funds was part of a broader reduction in fees by Fidelity.
Lower Fees Nearly Across The Board For Fidelity Index Funds
For three-fund portfolio investors at Fidelity, the Fidelity Total Stock Market Index Fund now has a 0.015% expense ratio (previously 0.035%). The Fidelity U.S. Bond Index Fund (FSITX) now has an expense ratio of 0.025% (previously 0.045%). The Fidelity Total International Index Fund (FTIPX) now has an expense ratio of 0.06% (previously 0.10%).
No Minimum Investment For Fidelity Index Funds
If that wasn’t enough good news for Fidelity investors, Fidelity also stopped having minimum investments in order to get the lowest expense ratios. Previously, retail investors had to invest a minimum of $10,000 in a single fund in order to access the lower cost Premium shares, while those who wanted to invest less than $10,000 in an index mutual fund would have had to use the higher-cost Investor shares, which still had a $3,000 minimum. Now, there is no minimum investment for Fidelity’s index funds, and all share classes have the same expense ratio. Previously, Schwab was the only major index fund provider that had no minimum investment for their index mutual funds.
Wider Range of Commission-Free ETFs
Vanguard made news in June 2018 when they announced that they would offer over 1800 ETF’s commission free, including funds from major index ETF providers such as iShares.
Fidelity, as part of their changes, expanded their set of commission-free ETFs to 265 ETFs (iShares and Fidelity) – previously they had fewer than 100 commission-free ETFs. With these ETFs, you can build almost any index portfolio commission-free.
Summary of Fidelity Fee Changes
To summarize, here are the changes Fidelity made in August 2018 to their fee structure:
- Introduction of two zero expense ratio index funds, FZROX and FZILX.
- Nearly across-the-board reductions in their existing index fund expense ratios.
- Elimination of investment minimums to buy their lowest expense ratio index funds.
- Expansion of the number of Fidelity and iShares commission-free ETFs.
What do these changes mean for you?
All index investors will be affected, directly or indirectly, from these Fidelity announcements.
Existing Vanguard and Schwab Investors Should Not Switch
I would not recommend existing Vanguard and Schwab investors to move their money to Fidelity to buy the Fidelity ZERO index funds.
The difference between paying 0.00% for Fidelity ZERO index funds and paying 0.03-0.07% at Vanguard or Schwab will not be the difference between a good and a great retirement. In fact, if you liquidate your Vanguard or Schwab index funds from a taxable account, you will hurt yourself by creating capital gains taxes.
Fidelity may be the first company to offer zero expense ratio index funds, but I doubt they will be the last. I expect Vanguard and Schwab to offer their own zero expense ratio index fund in the coming years, especially if the Fidelity ZERO index funds gain traction (which I expect they will).
Fidelity may be the first company to offer zero expense ratio index funds, but I doubt they will be the last. Click To TweetEven Fidelity Investors Should Not Buy FZROX Or FZILX In Taxable Accounts
Even Fidelity investors should not sell investments in their taxable accounts to buy the Fidelity ZERO index funds. As with Vanguard and Schwab, selling shares in a taxable account would incur capital gains taxes. These taxes blunt the compounding power of your investments, which would overwhelm the tiny expense ratio benefit from the new Fidelity ZERO funds.
I would also argue that you should not put new money into these index funds within a taxable account. Mutual funds are slightly tax-inefficient compared to ETFs, because mutual funds have to distribute capital gains, which are taxable, while ETFs do not. This erosion in after-tax returns is likely greater than the difference in expense ratios between the Fidelity ZERO index funds and commission-free iShares ETFs, such as ITOT or IEFA.
Fidelity Investors Should Consider Choosing The Fidelity ZERO Mutual Funds In Retirement Accounts
In retirement accounts such as a Roth IRA, you can certainly exchange your current index funds for FZROX or FZILX funds, since selling shares within a retirement account do not incur capital gains taxes.
However, it is important to keep perspective that you would save only $15 per $100,000 invested per year in FZROX over FSKAX and $60 per $100,000 invested per year in FZILX over FTIHX or FSGGX.
The Fidelity ZERO Index Funds Track Unique Indices
Fidelity has created new reference indices for their new Fidelity ZERO mutual funds.
FZROX tracks the Fidelity U.S. Total Investable Market Index, while FZILX tracks the Fidelity Global ex U.S. Index.
I am not concerned about tracking error with the use of internal reference indices, because these indices are publicly available and the reference index return can be tracked by third parties. Both the Fidelity U.S. Total Investable Market Index (used by FZROX) and the Fidelity Global Ex US Index can be tracked on the S&P Dow Jones website, and I don’t anticipate that their tracking error will be significantly different from FSKAX and FSGGX, respectively.
Fidelity Will Gain Market Share In The Short Run, Especially Among New Investors
There is something magical about the word free. Even though it was a cut of only a few basis points, Fidelity’s ability to claim a zero expense ratio mutual fund will stick in investor’s minds far more than previous expense ratio cuts in their funds.
I fully expect that this change will help Fidelity gain more market share than Vanguard’s addition of commission-free ETFs. If this happens, expect Vanguard and Schwab to offer their own zero expense ratio index funds to compete.
Where Do Expense Ratios Go From Here?
There is speculation on the Internet that with zero expense ratio index funds now being offered to investors, a negative expense ratio index fund could be on the horizon. In this scenario, fund companies would actually pay investors to invest in their index funds.
I’m not sure this is the next step in the fee wars. If the Fidelity ZERO index funds succeed, I expect Fidelity to expand their ZERO index fund series to additional asset classes.
At some point, investors will realize that you can get zero or near-zero expense ratio index funds at Vanguard, Fidelity, or Schwab. These companies will need to work on other things like offering even better customer service or improving their website and app interfaces to gain market share.
Conclusion
Investors should welcome the introduction of two zero expense ratio index funds by Fidelity, even if they do not personally invest in them. It is a sign that Vanguard, Fidelity, and Schwab are continuing to undercut each other’s fees in order to attract your investment dollars.
Other than within a Fidelity retirement account, I would not advise selling any current investments to buy these funds. Fidelity investors can consider investing new money into these two new index funds within a retirement account.
What do you think? What excited you the most about Fidelity’s new changes? How do you think Vanguard and Schwab will respond to these changes? Do you plan to buy either of these two new Fidelity ZERO index funds?
Great point about tax implications for those considering switching in a taxable brokerage account. That alone is why I would not switch (plus I really am loyal to Vanguard for what they have done always putting investors first).
Where do you suppose Fidelity recoups its money? I would think the majority of the clients that would come on board would only invest in the zero funds and not look at higher fee offerings.
https://www.quora.com/How-is-fidelity-going-to-make-money-with-no-fee-index-funds
This Quora question highlights some of the ways Fidelity will make money if you invest with them.
It should be noted Fidelity recently stopped giving away free miles and points as signup bonuses (with the exception of a short lived $200 match for $200 offer). Schwab still gives away $100 for opening an account, and Merrill Edge has subzero fees if you consider the signup bonus and added bonuses under BoA Preferred Rewards. I would love to see a bonus war between brokers; many folks used to move accounts around soon after the crash since ACATs were reimbursed and holdings left intact, although you had to keep track of your cost basis.
It’s certainly one incentive they can use, and many regular banks (e.g. Chase) still routinely offer signup bonuses.
I am age 61 retired military and disable veteran and just started investing in mutual fund. I do not have earned income my only income is Army retirement pay (E8) about 3600 per month (after tax and VA disability pay 90% which is about $2,044,per month. In a few months i will turn age 62 and wI plan to claim social security which according to my SS statement will be about 1,340 per month… after tax SS will likely be about $1000 per month.
Wife and I started a zero fee Fidelity FZROX (total stock market) fund current value (around $2k) about 6 months ago and put $300 per month in it. We also have a Vanguard Wellesley fund (current value 6K) we have had it about 2 years and we put $300 per month in it most months. we needed a new water heater and new shingles for roof so for a while we only put in about $50 a month till those were paid off.
we aim to toss my whole SS into Wellesly about $1000 per month and increase FZROX to $600 per month. We have about 10K in cash reserve account in USAA and 2K in CDs also from USAA bank.
thinking about maybe getting the fidelity zero fund international fund FZILZ and maybe investing $100 per month in that just for some international exposure. wellesly already has about 60% bonds in it so i dont plan on a fidelity bond fund.
Confident in fidelity so far and their web interface is easier to use IMO. but really wheter it’s vanguard fidelity or schwab any of the big 3 are good for investers especially new late start investers like my wife and I .
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