Fidelity’s Zero-Fee Index Funds: Are They Too Good to Be True?

In the fiercely competitive world of investing, Fidelity threw down the gauntlet in 2018 with the launch of its zero-fee index funds. These funds, offering exposure to the broad U.S. stock market and total international stock market, promised investors a way to build wealth without the drag of expense ratios. But are these zero-fee funds truly as good as they sound? Let’s delve into the details and explore the potential pros and cons.

What are Fidelity’s Zero-Fee Index Funds?

Fidelity currently offers two prominent zero-fee index funds:

• Fidelity ZERO Total Market Index Fund (FZROX): Tracks the performance of the Fidelity U.S. Total Investable Market Index, providing broad exposure to the entire U.S. stock market, including small, mid, and large-cap companies.
• Fidelity ZERO International Index Fund (FZILX): Tracks the performance of the Fidelity Global ex U.S. Index, offering exposure to international stocks excluding the United States.

The Allure of Zero Fees

The biggest draw of these funds is, of course, the zero-fee structure. In the past, even low-cost index funds charged minimal expense ratios, typically ranging from 0.03% to 0.10%. While seemingly small, these fees can accumulate over time and erode returns, especially for long-term investors. Eliminating these fees entirely allows investors to keep more of their investment gains.

The Benefits: A Closer Look

• Maximized Returns: With no expense ratios, your returns theoretically mirror the index performance more closely. This is a significant advantage, especially for those seeking passive, long-term growth.
• Easy Access to Diversification: These funds provide instant diversification across a wide range of stocks, reducing risk compared to investing in individual securities.
• Simplicity and Transparency: Index funds are designed to track specific benchmarks, making them easy to understand and track.
• Ideal for Beginners: The low barrier to entry and simple structure make these funds excellent options for beginner investors.

The Fine Print: Potential Downsides

While the zero-fee proposition is attractive, it’s important to consider potential downsides:

• Proprietary Indexes: Fidelity’s zero-fee funds track proprietary indexes, not widely recognized benchmarks like the S&P 500 or the MSCI EAFE. While the performance of these indexes has been comparable to well-known indexes, some investors prefer the transparency and track record of established benchmarks.
• Limited Availability: These funds are primarily available through Fidelity brokerage accounts. This could be a limiting factor for investors who prefer to use other brokerage platforms.
• Loss Leader Strategy: Critics argue that Fidelity uses these funds as “loss leaders” to attract new customers and cross-sell other products and services with higher fees. While this might be true, it doesn’t negate the benefits investors receive from the zero-fee funds themselves.
• Potentially Higher Turnover: There’s a possibility that Fidelity’s proprietary indexes may have higher turnover rates than more established indexes, leading to slightly higher tax implications for investors in taxable accounts. However, this has not been definitively proven.

Beyond the Zero-Fee Funds: Other Considerations

While FZROX and FZILX are compelling options, consider the broader investment landscape:

• Other Low-Cost Options: Vanguard and Schwab offer incredibly low-cost index funds that track established benchmarks like the S&P 500. While they aren’t zero-fee, their expense ratios are often very close to zero (around 0.03% to 0.04%).
• Tax Efficiency: For taxable accounts, consider the tax efficiency of different funds. While the zero-fee funds aim to be tax-efficient, comparing their historical performance to other low-cost options after taxes is crucial.
• Investment Goals and Risk Tolerance: Your investment choices should always align with your individual financial goals and risk tolerance. Consider consulting a financial advisor to determine the best investment strategy for your specific needs.

The Verdict: A Powerful Tool, Use Wisely

Fidelity’s zero-fee index funds are a valuable tool for investors seeking low-cost, diversified exposure to the U.S. and international stock markets. The absence of expense ratios can significantly boost long-term returns. However, it’s crucial to understand the nuances of proprietary indexes and consider alternative low-cost options before making a decision.

Ultimately, the best investment strategy depends on your individual circumstances. By carefully weighing the pros and cons, you can determine whether Fidelity’s zero-fee index funds are the right choice for your portfolio. If you are looking for a simple and low cost way to invest, the Fidelity Zero Funds are a great option. Just make sure they fit into your overall portfolio strategy.

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