Fidelity’s Free Mutual Funds

Posted on October 27, 2020 Updated on October 27, 2020

If you read financial blogs or follow the financial news, you’ve probably read multiple articles about Fidelity’s free index mutual funds. Yes…completely free with a 0% expense ratio.

What does this mean for the military investor? Let’s take a look…

What Happened?

All of the major investment companies – Fidelity, Schwab, and Vanguard – are competing for your business by lowering their investment fees. Vanguard has been the low cost 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:

1. The lower your investment fees, the more of the investment return you get to keep.
2. Costs last forever.
3. You should invest with low cost, broadly diversified index funds.

As you might have guessed, this is what I do at Vanguard and with my Thrift Savings Plan (TSP) accounts.

In 2018, 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.

Fidelity Mania

When this announcement came out, there were countless news articles and blog posts about the free funds. 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 (except for the Thrift Savings Plan G Fund), 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.

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?

I hate to reinvent the wheel, so those interested in the details should really read his article.

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, IRA, or the TSP), 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 (FSKAX), 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.

In addition, you can’t underestimate the benefit of simplicity when it comes to your investment portfolio. I had the TSP and Vanguard. That was it. Then my wife changed employers and now we have a less than optimal 401k with Fidelity that drives me nuts.

While I keep track of everything with a Google spreadsheet and that makes it pretty easy, having yet another website (Fidelity) I have to log in 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 or you haven’t invested outside of the TSP yet, 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?

1. If you’re already invested with Fidelity, enjoy the new free funds and use them for your US and international stock investments.
2. If you haven’t picked an investment company outside the TSP yet, Fidelity is certainly one to consider but I’d still go with Vanguard if it was up to me.
3. 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

What is an Expense Ratio?

Posted on October 21, 2020 Updated on October 20, 2020

Whether you are managing your investments by yourself or getting help, you need to understand one critical concept, the expense ratio of your investments. Every mutual fund and exchange-traded fund (ETF) that you invest in has an expense ratio, and keeping it as low as possible is key to your long-term financial success.

What is an expense ratio? An expense ratio is the percentage of a fund’s assets that is used for expenses. In other words, if you invest in a mutual fund with a 1% expense ratio and that fund makes 10% in 2020, you’ll only get a 9% return on your investment because 1% goes to pay expenses. The less of your return you use to pay expenses, the more you get to keep.

What is an average expense ratio? An average stock mutual fund has an expense ratio of 0.6% in 2019, but the expense ratios for mutual funds that are similar in their composition can vary wildly. For example, if you look at a list of Standard & Poor 500 index funds offered by investment companies, you’d find expense ratios as low as 0.04% (like the TSP C Fund) and as high as 2.43% (ticker RYSYX). While 2.39% does not seem like that large of a difference, keep in mind that costs last forever and that small differences compounded over years will cost you a lot of money.

Let’s pretend that when you are 25 years old your grandparents give you $10,000 to invest in an S&P 500 index fund for 50 years, during which you earn a 9.5% return. If you invested in an average mutual fund with a 0.6% expense ratio, you would have $683K. If you invested in the Vanguard index fund (another low cost S&P 500 index fund like the TSP C Fund) with a 0.05% expense ratio, you would have $902K. That 0.55% difference in the expense ratios cost you $219K! Small differences in expenses can make huge differences in long-term investment returns, so you need to pay attention to the expense ratios of your investments.

This difference is even more dramatic when you compare actively managed funds to passively managed index funds. Because actively managed funds have higher expense ratios than index funds, it is very difficult for an active manager to beat his/her comparative index over the long-term. This is why I invest 100% in index funds.

When you are picking your investments, keep in mind that you can’t control what happens to the market, but you can control which investments you choose and the expenses that they charge. Any time you are looking to invest in a mutual fund or ETF, you should search for similar funds and compare expense ratios, which you should try to keep below 0.5% (or even 0.25% if possible). Make sure that at a minimum you take a look at the Vanguard version of the investment you are considering since their expense ratios are among the lowest in the industry and they never charge extraneous fees, like loads. There is no reason to pay more expenses for what is essentially the same investment product. It could cost you A TON of money over the long-term.