With all of the political and financial noise of this week you would totally get a pass if you missed the most important small investor news for quite some time. What’s so important?
In the blog entry titled “Tale of two 401Ks” I spoke about the effects of expenses on long term investments. Remember Sally and Mark? Both work in corporate veterinary medicine and have company 401Ks. Sally decides to invest in a combination of no-load low-cost index mutual funds while Mark picks a managed “lifecycle fund”. They both save the same amount – $503 a moth – and manage to earn 6% but when they go to retire, Sally (blue line) has $128,000 more than Mark (Red Line). This is because Mark’s pick had an expense ratio of 0.66% while Sally’s strategy had an expense ratio of only 0.14%. Because of this, Sally retires with $128,000 more than Mark and that will pay for quite a few vacations or a down payment on a summer home or maybe she will just enjoy the security of just having some extra cash. Who knows? The point is that small changes in the expenses charged by an investment can result in big changes in outcomes.
Why no-fee funds are a big deal.
This week, Fidelity Investments made a truly significant announcement that somehow flew right under the news radar: No-fee stock index funds! That’s right, now you can invest in a stock index fund that charges absolutely no fees! How would things have turned out for Mark and Sally if she had picked this investment? Mark would still retire with $852,101 but now Sally (Black Line) will have over 1 million dollars!
Why is Fidelity doing this? After all you cannot make money charging zero. They are hoping that expense savvy investors will come for the free stuff and stay and invest in their other, more profitable financial instruments. What will other low-cost investment firms (e.g. Vanguard) do? To early to tell, but I would bet that we will see comparable products being offered in the next 6-12 months. So if you are happy where you are, you could wait for a while and see. Are these no- fee stock index funds right for you? Maybe, maybe not, but you owe it to your self to check them out!