The mutual fund fee arms race

A few weeks ago we talked about mutual fund fees.  There’s a big range, and one of the ways I win when investing is by minimizing the fee that I pay.  It begs the question: How low can mutual fund fees go?

Quick historical perspective

Mutual funds have been around for a long time, dating back to 1924 with Massachusetts Investors Trust.  Back then they had a management team that actively picked which stocks to invest in, very similar to the actively managed mutual funds of today.  Just like today, those mutual fund managers were paid handsomely.

In 1976 Vanguard started the first index mutual fund based on the S&P 500.  Just like today, the index mutual fund had costs significantly lower than its actively managed peers.  At first, the index idea didn’t catch on, but over the next 40 years it became the dominant investment vehicle for ordinary foxes. 

Race to the bottom for fees

Because index mutual funds are a bit of a commodity, the real differentiator is management fees.  I started investing in 1996 and I remember that my S&P 500 had a management fee of 0.30%.  At the time that seemed super low.  Today, that same mutual fund has a management fee of 0.14%, and if you get their Admiral Shares (at least $10,000 invested) the fee goes down to 0.04%.  DEFLATION!!!

Of course, that begs the question, how low could management fees go?  Fidelity answered that this summer when they launched a line of index mutual funds with a management fee of 0.00%–NO FEE!!!

There’s no such thing as a free lunch, so why would Fidelity do this?  It seems like a simple marketing ploy of having a loss leader.  They’ll lose a little bit on these mutual funds to get customers with the hopes that they get other products/services from Fidelity.

How big a deal is this?

Obviously getting something for free is better than paying for it.  Let’s figure out how big a deal this really is.

As we just said, Vanguard offers a US index mutual fund with a 0.04% fee.  International funds are a bit more expensive to manage and Vanguard’s is at 0.11%.  If you’re diversified as I have suggested in our Three Ingredients post, let’s assume your average management fee is 0.08%. 

So how much are you saving by going with Fidelity’s zero-fee mutual funds over Vanguard’s index funds?  If you had a million dollar portfolio, that would come to about $800 per year.  That’s not a ton of money, but it’s enough for Foxy Lady and I to go out to dinner once a month, so that’s kinda nice.

But the real value comes in when that money compounds over time.  Over an investing lifetime that little bit would add up to about $41k.  Again, that may not seem like a lot, but it’s about as much as the average American has saved, so maybe it is a lot.

For us, I think we’ve been with Vanguard so long that it would be hard to convert over to Fidelity’s zero-fee funds.  There’s the tax implications of selling the funds and paying capital gains which would be a lot.  Plus, there’s the inconvenience of resetting everything up again.  Finally, there’s the risk that I would get caught out of the market while my money was being transferred.

The first reason (the taxes) is probably the real reason.  $800 per year pays for a lot of hassle.  However, if I was advising someone just starting out who hadn’t already chosen Vanguard, I think this would certainly tip the scales in Fidelity’s favor—I would recommend they go with Fidelity and those zero-fee funds.

Either way, the point is that management fees are really going to the basement and then lower.  That’s a real boon for investors. 

One thought to “The mutual fund fee arms race”

  1. Thanks for the information — did not know about Fidelity’s no-fee funds. My wife and I will have to check them out! We’re also Vanguard customers and, like you, won’t be compelled to move our investments to Fidelity just for this, but the next time an opportunity comes along to invest, we’ll look at Fidelity first.

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