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Should You Invest in Fidelity's New Zero-Fee Funds?

There may be no free lunch, but there are now four index funds that charge nothing for management.

Index funds have always been cheap, with fees ranging from about 0.25 percent to as little as 0.04 percent. But their costs hit bottom with the launch last August of four funds that charge absolutely nothing. “There are no hidden fees,” says Robert Beauregard, a spokesman for Fidelity, which introduced these products. “Investors will not pay any expenses.” 

The funds—which the company says have already attracted $2.25 billion—include Fidelity Zero Large Cap Index Fund, Fidelity Zero Extended Market Index Fund, Fidelity Zero Total Market Index Fund, and Fidelity Zero International Index Fund. All four appear to mirror S&P indexes that their names don’t reference, ostensibly so Fidelity can avoid paying a license fee.  

The new offerings represent part of a move to push down costs for index-fund investors, Beauregard says. He adds that fees for owning such Fidelity funds have dropped in half in the past few years, saving $47 million annually for investors.

Low fees are the legacy of Vanguard’s recently deceasedfounder, Jack Bogle, who argued that mutual funds—particularly those that simply track a market index without requiring managers to pick stocks—should cost as little as possible. Bogle emphasized that fees are one of only a handful of factors that investors can control. 

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And they can be a big factor indeed, says John Zimmerman, president of Ascent Private Capital Management. If your funds return 5 percent and you spend 1 percent on fees, you lose 20 percent of your profits, he says. You also lose the opportunity for those profits to remain in the funds and grow.

“Every investor should be fee-conscious,” Zimmerman adds. 

So should you opt for zero-fee funds? Maybe, but “make sure you get the full picture and understand where the profit motives of the issuers may lie, either in that product or other products they may market to you once you’re in this zero-cost fund,” says Chris Kerchoff, CEO of financial advice firm Plancorp. 

There are always costs associated with running a fund, even one that passively tracks an index. So if the shares are offered with no charge for management, the investment company is subsidizing those costs as a marketing expense to attract customers to its other products, which do charge fees.

“Effectively, it’s a loss-leader strategy, much like when a supermarket doesn’t make money on the gallon of milk it sells at the back of the store,” says Ben Johnson, director of global ETF and passive strategies research at fund research firm Morningstar.

Keep in mind, too, that fees are sometimes worth paying. In some market sectors, actively managed funds can produce better returns than indexed ones. So can private equity, hedge funds, and other alternative investments that charge significant fees.

Consider, also, that if you’re already using index funds, you may be paying as little as 0.10 percent in annual fees. If so, moving $100,000 into a zero-fee fund would save you just $100 each year. Fidelity’s zero-fee funds, moreover, don’t yet have a track record, and you can’t be sure they will do a good job of matching the indexes they’re supposed to be mirroring. 

Before choosing a fund based on its fees, says Kinniry, check the fund company’s history to try to get a sense of how committed it is to keeping costs low over time. In a down market, companies—even Vanguard—sometimes raise their fees. 

Another caveat: If your existing investments are in a taxable account rather than a tax-sheltered or tax-free one and have risen in value, you’d owe taxes on your gains if you were to sell. In that case, you might be better off sticking with what you’ve got than benefiting from the lack of fees in the new Fidelity funds, Kinniry says. 

Here's what the Fidelity spokesman said: " In fact, as our index AUM increased from $200B to more than $400B over the past few years, we reduced our index fund pricing by 50%. These cost reductions will save shareholders approximately $47M annually."

You can't know for sure (and nobody has as good a reputation as Vanguard in this area). What you can do is avoid the equivalent of teaser rates. If a company known for regular-sized fees suddenly offers a no-fee fund, he's saying to treat carefully.