Generally, I’m against wars whether they are trade wars or the more traditional type of wars. However, there is a war that’s raging right now that I am in favor of, and that is a price war that is being waged by mutual fund companies. The latest shots fired were from Fidelity Investments who just announced the introduction of two new index funds that will have zero management fees. The two funds Fidelity is introducing are Fidelity Zero Total Market Index Fund (FZROX), which will invest in the largest 3,000 U.S. companies based upon an adjustable market cap; and the Fidelity Zero International Index Fund (FZILX), which will hold the top 90 percent of stocks within certain developed international and emerging countries.
There has been an ongoing war being waged by some of the top financial firms in the country. Companies such as Fidelity, Vanguard, Charles Schwab and Blackrock are lowering fees to investors and as far as I’m concerned, this is a good thing. After all, fees do matter and as investors if you can save on fees it will increase your return, and after all, isn’t that what it’s all about?
In investing I have always stressed the importance for all investors to understand fees. Fees are material and do have a significant impact on your return. All too often, Wall Street and many financial advisors are not transparent with fees and as a result many investors get taken advantage of. That is why it is important to understand the fees involved before you invest.
In mutual fund investing there are a variety of fees that you should be aware of. The first is the commission also known as the load. Plain and simple, a commission in mutual funds is money that comes out of your pocket to pay the salesperson who is putting you into the investment. For example, if you had a mutual fund that charged you a five percent commission, that means that if you invested $10,000 into that fund, $500 would come off the top to pay the salesperson. That would leave you $9,500 invested, not $10,000. On the other hand, if you invested in a true commission-free fund and you invested $10,000, all $10,000 would go to work for you. Therefore, in a true commission-free fund, since you would have more money invested you would ultimately earn more money on that investment. It is important to remember that commissions can come in a variety of different forms. It could be up front, like the example I just gave you, or sometimes they will hide the commission by increasing the management fee. You will see this frequently, particularly in B and C share mutual funds. The bottom line, commissions come out of your pocket and have a negative impact on your return.
The other expense that you pay in mutual funds is the expense ratio. The expense ratio is what the mutual fund company gets paid on a yearly basis to manage the money within the fund. On average, management fees on mutual funds are about one percent. Of course, many mutual funds, particularly those that charge commissions, have significantly higher expense ratio. Every mutual fund, until now, charged an expense ratio. Fidelity has become the first company to offer a true zero cost mutual fund that has no commission and no expense ratio.
Fees are important and they make a significant impact on the bottom line. If for example you are able to reduce your fees by one percent a year, and if you assume that on average you earn about seven percent a year, by reducing your fees by one percent you are increasing your return by nearly 15 percent. That isn’t 15 percent at once; rather, it is year after year and trust me, that adds up.
In Fidelity’s announcement, most of the talk has surrounded the zero fees. However, there was also another part of the announcement that I think is significant that has not received much publicity, and that is that there will be no minimums on these index funds. Therefore, investors with small amounts of money to invest can open one of these funds to get started in the investment world. I think this is wonderful news, particularly, for new investors. In fact, Fidelity now offers many funds you can invest in without a minimum and I think is great news for investors.
If you would like Rick to respond to your questions, please email Rick at firstname.lastname@example.org.