As an investor, you may have come to know that lower investment expenses can mean a big difference over time.

The expense ratio of a mutual fund is the most common cost of investing in funds.

To cut that cost out…

Fidelity is rolling out the first ever zero expense ratio self-indexed funds for individual investors.

They’re also providing zero investment minimums, account fees, and account minimums, as well as significantly reduced expenses on existing Fidelity index mutual funds.

Will these changes be a game changer in the investment world and your investment portfolio?

What Are Index Funds with No Expense Ratios?

Fidelity refers to these new zero expense ratio mutual funds as Fidelity ZERO Index Funds.

They come with the following perks:

  • Zero minimums to open accounts.
  • Zero account fees.
  • Zero domestic money movement fees (no charge for domestic bank wires, check stop payments, returned checks, and low balance maintenance fees).
  • Zero investment minimums on Fidelity retail and advisor mutual funds and 529 plans.
  • Significantly reduced and simplified pricing on existing Fidelity index mutual funds.

Is it any wonder they’re referring to these as Fidelity ZERO Index Funds?

This is no small development.

Fidelity is one of the largest index mutual fund providers in the world.

They have more than $7 trillion in total client assets under management for more than 27 million people and have been in business for over 70 years.

This change to zero pricing will represent a sweeping change in the investment world, but particularly in regard to mutual funds.

One of the arguments against mutual funds – at least compared with exchange-traded funds (ETFs) – is that mutual funds have higher fees.

Apparently, Fidelity is setting out to completely change that arrangement.

Why No Fee?

In short, Fidelity is recognizing the shift from active investing – which results in significant investment fees – toward passive, index investing.

Index investing involves investing in popular market indices.

Since the fund essentially replicates the underlying index, there’s very little trading within the fund.

That translates into very low investment fees.

Trading only happens when the components of the underlying index change, and the fund needs to either buy or sell new positions to stay consistent with the index.

The numbers don’t lie…

It’s certainly a win for investors, who will pay lower investment fees. But it’s also an indication Fidelity intends to remain one of the top investment firms in the world.

Fidelity is rolling out two different funds in this category:

  • Fidelity ZERO Total Market Index Fund, and
  • Fidelity ZERO International Index Fund

Fidelity ZERO Total Market Index Fund (FZROX)

A fund that seeks to match the total return of a broad range of publicly traded companies in the US.

Fidelity ZERO International Index Fund (FZILX)

A fund that seeks to provide investment results that match the total return of both foreign developed and emerging market stocks.

No performance data yet

Naturally, since the funds were just released, there is no investment performance information available on either.

Notice that the net expenses on each of the two funds are lower even than the microscopic expenses on popular competing funds from Vanguard and Charles Schwab.

FirmFidelityVanguardCharles Schwab
Fund nameFidelity ZERO Total Market Index Fund (FZROX)Vanguard Total Stock Market Index Fund (VTSMX)Schwab Total Stock Market Index Fund (SWTSX)
Net expenses0.00%0.14%0.03%
Minimum investment$0$3,000$0
FirmFidelityVanguardCharles Schwab
Fund nameFidelity ZERO Total International Index Fund (FZILX)Vanguard FTSE All-World, Ex-U.S. Index Fund (VFWIX)Schwab InternationalIndex Fund (SWISX)
Net expenses0.00%0.23%0.06%
Minimum investment$0$3,000$0

Who Can Invest

If zero expenses are good news, the even better news is that these funds will be available to all investors.

These funds are available for taxable brokerage accounts, IRAs, and 401(k) plans. They’re also available to individual investors either directly from Fidelity, or through a financial advisor.

As advertised, there are no minimum initial investments or minimum account balances on either fund.

This is regardless of whether it is held in a taxable brokerage account or a retirement account.

Impact on Your Retirement Savings

Fidelity’s ZERO index funds will provide an example of how very small changes in investment fees can add up to a significant amount of money through long-term investing.

Let’s make a comparison of two funds side-by-side.

Each has an annual average rate of return on investment of 10%.

Fund X is a typical index fund with an expense ratio of 0.25% per year. The fund provides a net annual rate of return on investment of 9.75% (10%, less the 0.25% annual expense ratio).

Fidelity ZERO index fund has an expense ratio of 0.00% per year. That provides a net annual rate of return on investment of 10%.

The investment results on $100,000 invested after different time frames will look like this:

Time fram10 years20 years30 years40 years50 years
Fund X$253,539$642,821$1,629,804$4,132,194$10,476,736
Fidelity ZERO index fund$259,374$672,749$1,744,938$4,525,920$11,739,071
DIFFERENCE$5,835$29,928$115,134$393,726$1,262,335

Now the difference after 10 years may be “only” $5,835, but remember – it’s earned without any additional effort.

The investor simply chose to invest in the Fidelity ZERO index fund, rather than the traditional index fund that has an expense ratio.

And as is obvious from the chart, the advantage of the zero expense fund grows with each year, and each decade.

As you can see…

If you have 50 years to invest, the absence of the seemingly insignificant quarter point expense ratio of the traditional index fund will rise to well over $1 million.

Converting Funds to ZERO Index Funds

Fidelity is lowering their fees on their funds across the board, so there’s nothing investors need to do if they’re already invested in one of the company’s many funds.

The big question:

Can a Fidelity investor move money from one of Fidelity’s other funds into one of the two ZERO funds?

The good news:

Fidelity does not charge a commission when you transfer funds from one Fidelity fund to another.

However, there will be tax consequences from the sale of previously held Fidelity funds. If the funds are sold at a gain, you will have a taxable gain on the sale of the current funds.

But since those are most likely long-term capital gains, you’ll get the benefit of lower tax rates.

Don’t Forget the Basics of Investing

Fidelity’s ZERO index funds definitely have the potential to improve long-term investment results.

And the elimination of investment minimums will certainly open the strategy to virtually all investors.

But while this represents a step forward in investment sophistication, the basics of investing should never be forgotten.

As efficient as ZERO index fund investing may be, it’s still important to include the following in your investing strategy:

Diversification

Fidelity’s ZERO index funds are targeted towards stocks, both domestic and foreign.

But you should not have a portfolio comprised 100% of stocks.

You should diversify your portfolio by including fixed income investments, like bonds, and cash equivalents, like money market funds.

And depending on your preferences, you may also want to broaden to alternative investments, like precious metals, cryptocurrencies, and real estate investment trusts (REITs).

ZERO index funds will improve your stock performance, but they don’t eliminate the need for diversification.

Risk tolerance

This is different for everyone and will determine how much exposure you should have to risk-related investments.

This includes any type of investment that has the potential to drop in value.

And even ZERO index funds have that potential.

No matter how well constructed the funds are, they are nonetheless tied to the underlying index. If the index falls – and all markets do – your index fund will go down with it.

Asset allocation

At that moment, Fidelity’s ZERO index funds are tied to very broad domestic and foreign stock markets.

But you may decide you want greater exposure to certain sectors, like high-tech, healthcare, or energy.

Until Fidelity extends their ZERO fund concepts to those sectors, you’ll need to continue to be invested in other index funds – or even mutual funds – even though they continue to have expense ratios.

What This Means for the Investing Market

Fidelity’s ZERO index funds are definitely good news. But we should also fully expect it’s only the beginning.

Fidelity will eventually expand their zero index funds to other asset sectors. This will include industry and country sectors, bonds, and other asset classes.

But the expansion is certain to go beyond Fidelity.

Others to follow

Major competitors, particularly Vanguard and Charles Schwab, will be left with no choice but to follow suit.

As they do, competition will heat up, and fund offerings will expand across the investment universe.

Smaller fund families will begin to offer similar products. And it’s a virtual certainty that robo-advisors will spring up based on the concept of zero cost index funds. It’s even perfectly logical to conclude that in time zero cost index fund investing will become the norm across the robo-advisor spectrum.

We should also fully expect that as more zero index funds become available, investors will show a natural preference toward them. Eventually, they may even refuse to invest in funds that have expense ratios, in favor of those that don’t.

Will that be the complete end of funds with expenses?

Probably not.

It’s one thing to go expense-free with index funds, but quite another with actively managed mutual funds.

And since mutual funds hold the possibility of outperforming the market, they’re unlikely to go away, even if they continue to charge fees.

But in the meantime, Fidelity’s ZERO index fund offerings are a definite win for investors, and a potential watershed event for the entire investment industry.

Kevin Mercadante is a former mortgage loan officer emerging from the Financial Meltdown as a self-employed “slash worker” – blogger/freelance blog writer – on Out of Your Rut. He offers career strategies, especially transitioning into self-employment, and provides “Alt-retirement strategies” for the vast majority of the rest of us who won’t retire to the beach as millionaires.

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