Fidelity Offers Two 0% Expense Ratio Index Funds
Over the past couple decades, mutual fund companies have been in a race to cut the cost of their investment funds, known as the expense ratio. Apparently Fidelity 'won' that race on 8/2/2018 when it introduced two index funds with 0% expense ratios. Additionally, the funds carry no minimum opening deposit and no annual account maintenance fee.
Fidelity® ZERO Total Market Index Fund (FZROX)
The first option is a total US market fund, which will choose a sampling of large, mid, and small US stocks to invest in. Fidelity intends this subset of stocks to match the overall U.S. stock market. Fidelity's Summary | Prospectus
Fidelity® ZERO International Index Fund (FZILX)
The second option is an international fund, which will choose a sampling of large- and mid-sized non-US stocks to invest in. With this subset of stocks Fidelity intends to match it's Global ex US Index. Fidelity's Summary | Prospectus
What Expense Ratios Pay For
Expense ratios have long been the target of investor's ire, as they lower the returns an investor gets each year. Assuming a fund has a 1% expense ratio, in a year the underlying assets returned 8% the investor would only get 7% return. And in a year the underlying assets lost 8%, the investor would lose 9% in the fund.
Expense ratios aren't evil, however, as they pay for the many required investor protections. Money generated by expense ratios is used by the fund company to pay for fund administration costs, SEC filings, disclosures costs, audits, and of course generate profit for the fund company. These are all necessary expenses of the fund company.
No Such Thing as a Free Lunch
The question then becomes, if the expense ratio isn't going to pay for these expenses, how will Fidelity pay for them?
A small amount of money can potentially be generated through Fidelity lending out shares within the fund to short-sellers, as Fidelity stated it will. But this likely won't be nearly enough to pay for the fund expenses. Fidelity could also pursue more aggressive (and riskier) strategies to generate revenue such as writing options contracts on the stocks within the fund. Even still, the revenue generated would likely be minimal compared to the true cost of operating the fund.
0% Funds As A Marketing Tool
The most likely answer, though, is Fidelity will use these funds as a 'loss leader' to then be able to upsell investors to higher profit funds and services. Considering the obvious attraction of a zero cost fund, Fidelity will be able to amass an enormous database of investors. From there, an equally massive marketing push could help sell Fidelity's other products to the investors in the fund. At least, that would have been my strategy back when I ran marketing departments for financial services firms.
Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. He is also the owner of Purposeful Strategic Partners, a Registered Investment Advisory firm. He can be reached for comment at info@purposefulfinance.org