Last September I got the following note from a reader of the blog:
Not sure if you caught some interesting news, but Vanguard’s rival Fidelity has introduced two ZERO expense ratio funds – one domestic and one international. Interesting maneuver to try and compete with Vanguard and ride the indexing wave:
Thoughts? I’m a die-hard Vanguard guy, but at 28 years old, the opportunity to shave costs over decades is appealing…
I told him it was SUPER intriguing, but like most things that try getting in the way of my already-locked-in-plans, I tend to ignore them until I actually can’t anymore ;) Similar to how I got into Vanguard to begin with – I finally couldn’t resist the logic from everyone!!
I told him to keep me updated over the months though – especially if he ends up making the switch – and then just yesterday I heard back from him again, offering to share his current insight in the form of a guest post.
So that’s what you’ll see now below – a little analysis from our friend here to help us all be better about keeping an open mind ;) And to avoid having rotten tomatoes thrown his way, he’s opted to remain anonymous, haha…
Take it away, Mr. Anonymous!
Let’s talk expense ratios and question conventional index investing for a moment. It’s important to do this sort of thing, especially when it becomes easy to get lulled into the belief that one product has always been and will always be the way to go, a la Vanguard for index fanatics. The “challenge everything” mindset is a must.
As a faithful follower of the indexing movement, I agree with and submit to all its fundamental assumptions and acknowledgements – passively mirror the market, avoid paying someone to mange your money (only to screw it up), understand that being “average” year after year actually puts you well above average over time, etc.
So, Vanguard it was.
My dad invests with them, and at the early age he got me started, of course I followed his suggestion. He gave me the autonomy to pick the investments I wanted, but they were going to be under Vanguard’s roof, no question.
With time and learning, I became fully committed to the indexing ways. I’ve now moved all my invested money to indexes and am 100% stocks. Why all stocks? Among other reasons, I read the Jim Collins article on Investing for Seven Generations and understood the point.
This money I invest is here to support all my wants and needs throughout my lifetime, yes, but it can and should be about so SO much more than that. It’s for generations of family I will never meet. So I increasingly look long-term – like, really long-term – and can easily subscribe to the idea of being 100% stocks, perhaps for the entirety of my life.
With a general philosophy now adopted, it’s tempting to become complacent. I’ve picked my investment approach, established my risk tolerance, and selected funds that match it (VTSAX, VTIAX and that’s it). Now it’s time to simply cruise, let the automation occur, keep the faith, and not worry about it, right?
Nope, can’t do it. I like to remain engaged and always stay current. That usually doesn’t mean too much in the passive indexing world, but there’s something new on the horizon and I’m intrigued…
That shiny, new thing? Fidelity’s zero expense ratio funds. They caught my attention in September of last year, shortly after Fidelity rolled out four funds that all tout a “0.00%” under that all-important expense ratio listing.
As an indexer, I pay close attention to this, and I know Vanguard has dominated the field for quite some time. The greater investing audience has also paid attention, as report after report tell a story of more investors adopting the passive investing approach, leaving their active fund managers behind.
But Fidelity has pushed the envelope. They didn’t go the Vanguard route and drop ERs by 0.01, as Vanguard’s been known to do periodically. No, Fidelity created four new funds and told investors “invest your money here and pay nothing”.
I was understandably skeptical at first. This went against what I’d known for quite some time and felt the need to keep my distance. So I did. I monitored the two funds I cared about most – FZROX and FZILX – and waited for something to change. Certainly, the funds wouldn’t remain at 0.00, I thought. There must be a point in the not-too-distant future when they’d quietly raise the ERs in the middle of the night. If not that, perhaps Fidelity’s funds couldn’t track their indexes as well as Vanguard, and the returns would be sub-par when compared to the market.
Those were my main concerns, and neither of them happened. The fund is still at an ER of 0.00 and the funds still track their index (and Vanguard’s matching funds) extremely well. See below:
By my assessments – and they may not be entirely comprehensive – the Fidelity funds check out. Now comes the “does it really matter” part. Am I really saving money by seeking a miniscule reduction in ERs? Based on what’s current on Vanguard’s page, investors pay an ER of 0.04% for VTSAX and 0.11% for VTIAX. Great, low rates by all accords, except now there’s something lower.
Time to bring in the expense ratio calculator.
A simple calculator I found is listed below. First, it’s important to tackle a couple of assumptions here:
- The money that I’m evaluating is what I have invested in a taxable account, meaning I can move it anywhere, anytime with no limitations. My choices are not limited by the options offered through an employer’s 401k selections.
- Everything I entered would likely be considered conservative. I did this in order to prevent an exaggerated effect from the difference in ERs. I assumed returns of only 6%, I reported that I would not be contributing ANY money beyond the principal amount of $300k, and I took projections out 60 years (remember, I’m thinking seven generations here, not just my lifetime).
- I actually used 0.03 for the VTSAX ER, not its current listing of 0.04. This is because the matching ETF, VTI, is currently at 0.03 and I’m making a guess VTSAX will drop to match it before too long.
- I also have money invested in VTIAX, as mentioned above. VTIAX is at 0.11% currently, but I’m not even factoring that in. I’m only evaluating the VTI ER of 0.03 and being extra kind.
That big number in green at the bottom? That’s the $166k I’d be paying to Vanguard over the next 60 years, just to have them manage my $300k plus it’s 60-year growth. STAGGERING!
One might argue that $166k over 60 years isn’t a huge deal and that with inflation, it will be less impactful in the future than it seems now. All good points, but remember my assumptions and purpose.
In reality, I expect to make a greater return than 6%. Also, I will obviously be adding to this investment over the years, not just letting the principal compound. And finally, I want this money to be passed on well beyond my lifetime! With all those “new” assumptions applied, the costs to manage the funds go up “bigly”! The larger the value of the investment becomes, the more that ER drags on my returns.
So what sort of action should and will I take? That’s the big question here. I’ve been sitting idly by for more than six months and not taken any action yet (always a cardinal sin), so should I be compelled to act? Maybe. I’m monitoring for a few things.
The first is the cost of closing out the Vanguard accounts and realizing all the gains. Having been invested over the last 9 or so years, there’s been some powerful growth in the stock market, and the gains would be taxable. That would hurt and make for an ugly time next April 15th.
If the capital gains tax deters me, what I might do instead is monitor for any downturns in the market. They inevitably happen and would actually give me a perfect exist strategy from Vanguard with lesser or no gains to be taxed on. Admittedly, it would have to be a pretty significant downturn, but that’s a good problem to have.
My international funds, however, have grown a lot less than the US funds, so, I could withdraw just the international portion and move it to Fidelity, purchasing the 0.00% ER fund that targets the exact same index. It would cost a lot less in realized capital gains. Would that constitute a wash sale? Would I have to sit on the sidelines for 30 days before entering Fidelity’s international fund? Those are not rhetorical questions – maybe someone can help me answer that.
The second option to consider is remaining idle, although this relies on a big assumption/hope: believing that Vanguard will also drop its ER to zero. I hate relying on things out of my control, which is exactly what I’d be doing.
Nevertheless, there’s plenty of literature out there claiming that zero ERs is inevitably where it all goes. The articles argue that investment firms will ultimately bend to the will of investors who increasingly demand ultra-low cost funds and will leave if their demands are not met. I tend to believe it will eventually happen, but how long must I wait and how much in fees will I lose while waiting? Impossible to answer. This is the conundrum I’m left with.
For new investors, I’d say the answer is easy: if you believe in the indexing philosophy, invest with the firm that offers you the cheapest way in. Right now, that appears to be Fidelity. I hear there are other, smaller investment firms that also offer 0.00% funds, but I also feel the need to be part of a larger, more substantial institution.
Where to go from here largely depends on getting oneself off the sidelines…
So there you have it! What do you think?? Have you been tempted to move over too, or perhaps you’ve always been a fan of Fidelity but just kept quiet amongst our sea of Vanguard lovers?? :)
The part that stuck out to me was the fact that if the Vanguard funds are outperforming fidelity’s as it looks like in that comparison up top, even if by just a fraction, wouldn’t it come *closer* to breaking even in the end? Making the fee differences not as important?
I coincidentally came across another Vanguard vs Fidelity article while reading about this (albeit in a more “review” type format), and one of the comments someone left at the bottom brought up an interesting point:
“One of the reasons Fidelity is able to offer Zero fee funds is that its not actually tracking the total market index. Instead they created their own total market index and avoided the index free – which is charged to all index trackers. Now this could be very similar or it could not. Time will tell. But in the meantime, would you like to actually track the total market index or not? That’s the question that the Zero fund investors should answer.”
So it’s not exactly *apples to apples*, even though of course it’s certainly close. But that does explain why the performance is off by a fraction… (and a fraction, mind you, that goes on to become quite the difference in the long term which is the precise point of this post!)
I relayed this over to our friend, who was kind enough to continue the discussion…
Sure, solid points. It is true that “time will tell” whether the Fidelity zero-fee funds will actually mirror their intended indexes and deliver returns on par with Vanguards indexes. Nice points by Money Wizard too.
With the screenshots I provided (current as of May 8th), I think it showed Vanguard to be ahead of Fidelity by 0.02% to 0.03% thus far in 2019. If Vanguard’s VTSAX should take a “lead” of 0.04% over Fidelity’s FZROX or more by the end of 2019, then it is true that switching to the Fidelity funds would have created no benefit. However, the lead that Vanguard would have to create for the VTIAX fund would have to be greater though, as VTIAX is currently costing 0.11% annually, while Fidelity’s matching fund is also 0.00%.
Vanguard themselves actually offer a cool “fund cost” calculator at https://personal.vanguard.com/us/funds/tools/costcompare. Using this, they introduce two different “costs” that an investor absorbs when paying a higher fee than needed.
- First is the incurred fee, which Vanguard describes as “the cumulative fees, expenses, and other charges associated with buying and maintaining shares”. That is super straight-forward and easy to process.
- Second are the opportunity costs, which represent “the compounded return you lose because you’d be diverting investment assets to pay fund costs instead of buying additional shares”. This gets at the lost “re-purchasing” power from losing 0.xx% to fees, which could otherwise be going towards buying up more of the fund through dividends. It does operate on the assumption that an investor chooses to have dividends reinvested, not paid out to them.
Finally, if it’s possible that Fidelity’s funds will slightly underperform Vanguard’s because they aren’t following the exact index (and are thus avoiding that small fee to do so), then I see that it’s also possible that Fidelity could slightly outperform Vanguard’s indexes.
There’s no secret “formula” to mirroring the index, so Fidelity can and hopefully did do their homework is studying exactly what a Vanguard fund like VTSAX invests in and tweaking it just enough so that they avoid paying the index-tracking fee, but are comprised of an equally large and equally diverse number of companies.
It comes down to a bit of what can I vs. can’t I control. I can control the fees I pay, but I can’t control the returns experienced over time.
Just my two cents.
One last illustration. This graphic below compares VTSAX and FZROX over the last six months (FZROX has only been around since August 2018) and it shows that at 1, 3, and 6 month periods, the funds have shuffled in terms of who’s generated better returns. VTSAX wins the six month battle, but if you wanted to withdraw your money at 1 or 3 months, Fidelity would’ve been the better option.
And that’s the end of this post for real ;)
UPDATE: Here’s another great article around this stuff from White Coat Investor: Don’t Obsess About Expense Ratios (thanks for the tip, Andy!)
UPDATE II: Got a note from our author here with a follow up:
Thought I’d follow up several weeks later.
I made a move to swap one of my Vanguard funds for a Fidelity ZERO fund. Specifically, I sold VTIAX (total international index) and bought FZILX (Fidelity’s same fund).
Couple reasons for this:
- The savings in ERs is greatest here (going from 0.11 to 0.00)
- I was essentially at zero profits or losses, so next to no incurred capital losses or gains (unclear if I could claim losses on this due to wash sale rules anyway)
- Good way to get my toes wet without a full commitment
Thought I’d share in case anyone was interested.
UPDATE III: Another update from our experimenter :)
Hey Buddy, I thought I’d do an end-of-summer check on the performance of Fidelity’s no-fee funds vs the Vanguard funds, just to see how the ongoing experiment is playing out. Below is what’s current as of yesterday’s market close. The domestic funds remain in a fairly close tie, but the Fidelity international fund seems to have pushed towards a bigger lead. Interesting stuff I’d say.
Jay loves talking about money, collecting coins, blasting hip-hop, and hanging out with his three beautiful boys. You can check out all of his online projects at jmoney.biz. Thanks for reading the blog!