Fidelity’s ZERO cost index funds
For years, index fund fees have been getting lower and lower in an industry-wide “race to the bottom”, as individual and institutional investors increasingly flock to low-cost index funds for their portfolios. For many investors, index funds are attractive because high expense ratios erode returns, yet most actively managed mutual funds do not outperform index funds over time.
In August 2018, Fidelity shocked the investing world by offering, for the first time, zero fee index funds: Fidelity ZERO Large Cap Index (FNILX), Fidelity ZERO Total Stock Market Index (FZROX), and Fidelity ZERO International Index (FZILX). These funds are widely believed to be loss leaders for Fidelity. They had no trouble attracting investments: FZROX, the most popular ZERO fund, now has almost $7 billion in assets under management (AUM). Of course, this still pales in comparison to their traditional total market index fund (FSKAX), established in 1997, with $54 billion in AUM. Vanguard’s popular Total Stock Market Index Fund (VTSAX) has over $921 billion in AUM, although this is divided between different share classes of the fund (which is irrelevant to this discussion).
How do ZERO index funds compare with equivalent index funds?
I will focus on FZROX for the rest of this article, as total stock market index funds tend to be the most popular type of index fund for passive investors. One criticism of Fidelity ZERO funds is that they track a proprietary index from Fidelity rather than a public index. As a result, the fund’s holdings are somewhat different:
| Fund | Index Tracked | Expense Ratio | Total Holdings | |||||
|---|---|---|---|---|---|---|---|---|
| FZROX | Fidelity proprietary | 0 | 2457 | |||||
| FSKAX | Dow Jones US Total Stock Market Index | 0.015 | 3438 | |||||
| VTSAX | CRSP US Total Stock Market Index | 0.04 | 3590 |
It appears that FZROX is slightly less diversified than a “true” total stock market fund and may be more likely to see tracking error (which is how much an index fund’s performance deviates from the index it tracks). Therefore, any cost savings from expense ratio is likely to be offset by slight tracking error over time.
I should also point out that index fund expense ratios are so low that they are basically negligible at this point. For every $10,000 invested, Vanguard’s “expensive” VTSAX only costs $4 per year, compared to $1.5 for FSKAX and $0 for FZROX. Obviously, chasing lower expense ratios is only fruitful to a certain point.
How has FZROX performed compared to FSKAX and VTSAX? Very similarly, at least for the past 2 years since their inception. If we perform a back-test on portfoliovisualizer.com with an identical initial investment of $10,000 into these three funds from September 2018 to November 2020, the results are $15,127 for FZROX; $15,135 for FSKAX; and $15,150 for VTSAX. Don’t read too much into these small differences; the ZERO funds are still too new to draw any meaningful conclusions about how well they will track the market in the long term.
Should I invest in ZERO index funds?
I believe this is personal preference. Existing expense ratios are already so low as to be negligible. Investors in existing funds have no reason to switch, as this will usually trigger a taxable capital gains event when you sell shares in one fund to purchase another. For new investments, I doubt that the ZERO funds will differ significantly in performance from traditional index funds, but that remains to be seen. Finally, ZERO funds are only available at Fidelity. Investors already using Fidelity may be more enticed to try the ZERO funds. Investors using other brokerages will need to decide whether they want to open a new brokerage account and use Fidelity’s platform. At the end of the day, while Fidelity has finally won the race to the bottom with their ZERO funds, I don’t think these funds have changed the landscape of passive, index investing.
Happy investing!
