Fidelity’s Zero-Fee Indexes Are A Perfect Fit For Kids
August 23, 2018

Fidelity’s Zero-Fee Indexes Are A Perfect Fit For Kids

“I wish I knew this when I was younger.” When I scan my book’s Amazon reviews this is the most common comment people write. They’re referring to the benefits of compound interest and how low-cost index funds beat most actively managed products.

Unfortunately, many people believe it’s too late for them. They didn’t start to invest when they were young. But they know their children can. Recently, I published, Don’t Punish Your Kids, Teach Them This Financial Lesson. The story includes an eye-popping table that compares different investment timelines. Investors who start when they’re young can save far less money and end up richer.

But young investors face a couple of hurdles. First, their parents need to open an account on their behalf. The money would belong to the child, but it would be held in trust until the child becomes an adult. UGMA accounts are popular for this purpose.

Low-cost index funds are the best investment option. But they often require a minimum investment. For example, Vanguard’s S&P 500 (VFINX) requires a minimum initial investment of $3000. Vanguard’s Target Retirement funds– which are among my all-time favorites–require at least $1000 just to invest in the funds. Parents could help their children reach these entry points. But that defeats a purpose. Children learn more when they earn their own money.

Fidelity’s new index funds might help a lot with that. On August 2, 2018, the firm introduced Fidelity’s Zero Total Market Index Fund (FZROX) and their Zero International Index Fund (FZILX). They don’t require a minimum investment. In theory, if your child saved $2, they could split their proceeds between both of these funds.

Fidelity’s U.S. index includes large-cap, mid-cap and small cap stocks, weighted based on market capitalization. In other words, it tracks the total U.S. stock market, much like Vanguard’s Total Stock Market Index (VTSMX).

Vanguard’s index charges 0.14 percent per year for investors with less than $10,000. When an investor’s fund assets exceed $10,000, Vanguard converts the fund to its Admiral Series equivalent: VTSAX. It charges a paltry 0.03 percent per year.

But Fidelity’s U.S. stock index and its international index don’t charge any fees. To be fair, there’s little difference between zero and 0.03 percent. That’s why, if you already have an account with Vanguard, it’s hardly worth switching. For example, a 0.03 percent charge on $10,000 would cost just $3 a year. In an adult’s taxable account, selling Vanguard’s index to buy Fidelity’s zero-fee equivalent might also slap investors with capital gains tax.

But for kids, Fidelity’s zero fee indexes are better than an unexpected holiday from school. There’s just one thing to remember. Some of Fidelity’s actively managed funds will beat their indexes. Unfortunately, we can’t know ahead of time, which those funds will be. Often, when investors see “better performing” funds, they climb into a different boat.

Fidelity counts on that. After all, Fidelity won’t make money from their index funds. In some cases, their advisors try to steer clients into their more expensive funds.

About eight years ago I helped my friend, Patti Smaldone, build a portfolio of Fidelity’s low-cost indexes. Four years later, she called Fidelity. She wanted to rebalance her portfolio, but she had forgotten how to buy and sell. The Fidelity rep waited for just that sort of break. “He asked me why I was in those products,” Patti explained to me. “And he said I should buy their actively managed funds instead, saying they’re much better.”

Unfortunately, funds that win during one time period rarely win the next. For example, every six months, SPIVA publishes its Persistence Scorecard. It looks at top-performing funds during specific time periods. Then it tracks those top funds to see how many keep winning. In March 2016, 557 U.S. stock market funds were among the top 25 percent of performers. Just two years later, only 2.3 percent of them maintained their winning ways.

But if investors stick to Fidelity’s zero-fee index funds, they should earn decent profits. They’ll just need a lot of patience and plenty of resilience. If an advisor says there’s more money beneath a rainbow, it’s best to stay put. Parents should also pass that lesson to their kids.

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This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

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