I have talked about the need to be conscious of fees when purchasing mutual funds and exchange-traded funds (ETF) but there is a new twist in the ETF world. Yes, fees on mutual funds were around 1% 30 to 40 years ago when Vanguard introduced the first indexed fund to the investing world. Today the low-cost leaders offer the total market index fund at Schwab for 0.03% or $3 for a $10,000 investment. No matter how you look at it that is pretty low and is not a major pull on your investment’s return. But what does a free offer on an ETF from Fidelity mean to the investing world?
Here is how we will approach this new revelation in the ETF world, Fidelity has indeed introduced two ETF’s that charge no management fees too own. But is free the best way to go? That is the question we will examine in this post. For years the low-cost leaders have been in a race to zero for years as they have gone from 1% a generation ago to fees as low as the 0.03% at Schwab and Vanguard’s 0.04% for their total stock market index funds. And now Fidelity has introduced the first 0.00% fund. Is there a major difference? Is free always better even when you are talking $3 and $4 in costs per $10,000 invested?
Yes, when we went from mutual funds in the start that charged well over 2% to indexed funds that charged 1% that started this revolution in fees and the race to zero. Look at it this way if you would, a 2% fee meant that per $10,000 invested it cost you $200 per year to own. Then that went to 1% and $100 a year for that same $10,000 invested. Now we are as low as .03% or just a measly $3 per $10,000 invested. That means we are now at least $197 better off per year investing in the low-cost ETF as compared to the older mutual funds. And yes, $197 in savings over 30 plus years in a retirement account makes a significant difference to your returns. So $3 will make a difference but not that much of one when compared to the older fee structure.
But is free the way to go and if so do you change or switch to Fidelity’s no-cost ETF? Well, being low-cost could be a major factor in your decision-making process. But it is not everything that needs to be considered as not all funds are created the same despite the fact they follow, in this case, the total market. According to Morningstar Schwab’s Total Stock Market index charges 0.03% and has an average annualized return of 10.62% after fees. Then compare that to Fidelity’s that did charge .02% with an annualized return of 10.53%, a slight difference of 0.09%. That means even if you elected for the now free EFT you would still be .07% better off a year paying Schwab’s 0.03% fee when compared to Fidelity’s free fund. So we now know free is not always better in the fund’s returns.
Then there are definitely tax considerations that may need to be taken into account as well. If the funds you plan on switching are in a tax-advantaged 401(k) or IRA, the tax issue will not be the main motive as the analysis of switching takes place. But if the account is in a taxable brokerage account, you will have to consider short or long-term capital gains taxes. So in a taxable account is free worth selling and creating what could be a significant taxable event? My guess is, in that case, most likely it is not, but everyone’s situation is unique and must be taken into account only after all the facts are known.
While free is not always better, especially at the beginning, that does not mean that Fidelity’s new free funds will not be a total game changer for the investing world. For more information or if you have a question feel free to contact me directly or leave a comment here.
