Fidelity has announced two zero fee funds available starting tomorrow.
A zero fee fund is an industry first. Yes, fund costs have been low and falling for many years. Nonetheless, the difference between a very small fund cost such as 0.03% and free is a material shift for the investment industry.
There are two free funds and both appear robust. The first tracks 3,000 larger U.S. firms, the second tracks larger non-U.S. firms.
Neither follows a specific named index such as S&P or MSCI which helps keeps cost low, though the investment results are unlikely to differ significantly over time from well-constructed similar 'branded' index approaches given that the index construction rules and rebalancing processes are similar.
Marketing stunt?
You're likely wondering what the catch is. There's no obvious one.
These funds are genuinely free. Fidelity can still make money on other services for clients. So Fidelity, is likely offering a loss-leader to get you in the door and get some attention.
This is the investing world's equivalent of a cheap TV at Walmart on Black Friday . Bear in mind that Fidelity offers over 500 mutual funds, currently only 2 of them are free.
Should you rush in?
Everyone loves free, but there are a few reasons to be cautious with your money. The first is that the fees on the fund aren't your only cost.
There are potential tax consequences with trading. Therefore, even if the cost is lower than your current fund, you may end up with an unwanted tax bill if you sell another fund that's risen in value to switch to the Fidelity alternative. Yes, you'll likely pay that tax at some point anyway, but if you're already in an investment that your happy with and the costs are very low, then there's little reason to pay that tax now. If you delay the sale you'll potentially earn extra money on the cash you would have paid in tax, over the coming years.
Secondly, the zero fee funds are mutual funds. Generally, mutual funds are a less tax efficient structure than ETFs.
So, in a taxable account, there may be a tax drag from owning these funds relative to a similar ETF depending on future market direction.
Nonetheless, if you're an index investor and paying over 0.25% in fees on your funds, then it's probably time to look at cutting your fees, especially if you're in a tax-advantaged account. These Fidelity funds are one way to cut your costs.
Here is a process for getting started with a basic low-cost portfolio.
Finally, remember that your goal should be to build an investment portfolio that make sense for you. You should avoid combining cheap funds without an overall plan.
For many people, these funds will need to be balanced our with other funds or ETFs as well that still have a cost attached to them, so we have free funds today, but not free portfolios at this point. Obviously, swapping out a bond fund for a stock fund that's free would save you money, but wouldn't make very little sense from a portfolio construction standpoint.
Is this is bottom?
It's unclear where the industry will go from here, but this is another positive event for investors.
A month ago, Vanguard made many ETFs commission free. So the costs of both owning and trading funds is falling in many places. However, this does not mean that profits are disappearing from the investment industry, the average equity mutual fund still charges 0.59% according to Investment Company Institute data.
Firms often make noise around announcements such as these, but remember that even Fidelity operates over 500 mutual funds, so even with this news less than 1% of them are free.
Of course, passively tracking an index can be done very cheaply, but active management still carries a greater cost, so a zero fee active fund is unlikely. It is likely that zero is the floor for funds, because even though securities lending revenue can help improve fund returns and possible support a fund that theoretically paid you money to hold it, securities lending revenue can uncertain, whereas fees are fixed.
Even in the best case, securities lending revenue typically amounts to under 0.05% annually. So if zero's not the floor, then we're getting very close. As as often occurred with these sort of announcements it will be interesting to see if there is any price reaction from other major providers who've been active in cutting prices over time such as BlackRock (iShares), Vanguard and Schwab.
Simon is author of Digital Wealth and CIO at Moola, he previously held the same role at FutureAdvisor/BlackRock. Articles are educational only, not intended as investment advice.
