Investing experts have questions how Fidelity can make money offering no-fee funds, but many ETFs are already offered at an expense ratio that is close to free. Mishra noted that ETFs from iShares — a key Fidelity brokerage partner — like the iShares Core S&P Total Stock Market ETF (ITOT), and ETFs from Vanguard, including its S&P 500 ETF (VOO), charge just three to four basis points, and "are almost as good as funds with zero fees."
Schwab also offers a series of U.S. stock index funds as low as low as 0.03 percent and 0.04 percent.
Fidelity's move to be the first mutual fund company to offer a no-fee fund came amid this intense competition over investing fees, not only at the level of the portfolio expense ratio, but over trading commission. Fidelity's announcement in August came out shortly before Vanguard Group launched commission-free trading on almost all ETFs. Fidelity raised near-$1 billion in the month after the launch of its first two no-fee funds.
Fidelity launched a range of "zero" incentives for investors in addition to the index funds: zero minimums for account opening, zero investment minimums on Fidelity retail and advisor mutual funds and 529 plans, zero account fees, and zero domestic money movement fees.
These moves should bring in more new business for Fidelity, but shouldn't compel investors already in low-cost funds to move. "Investors who currently own other ultra-cheap ETFs or index funds are fine staying where they are, particularly if there are tax implications in switching. Not only is the cost difference trivial, but also there are chances that your ETF provider would cut fees further," Mishra said. "For Fidelity, having new clients who will likely spend on other products once they join its platform is worth sacrificing some money on these loss leaders."
She said investors need to understand that while expense ratios are important in investment decisions, they become insignificant when the difference is just a few basis points. In fact, tracking error of a fund — the inability to perfectly replicate an index return — could be more than that.
But Mishra said Fidelity is proving that one basic marketing principle is working in the fund industry's first experiment with it: "Who doesn't love free stuff, and that applies to investing as well."