Fidelity recently introduced four zero expense ratio mutual funds. That’s right, there is no cost to invest in these funds. Believe it or not, mutual funds and exchange-traded funds (ETFs) that will pay you to invest in them are on the way.
Salt Financial’s SEC filing
As reported by Jeff Sommer in a recent New York Times piece, Salt Financial has filed with the Securities Exchange Commission (SEC) to offer a new stock fund that pays investors 0.05% to invest in it.
Salt Financial is using this strategy to build assets quickly in the new fund and therefore this practice will not be permanent. However, other funds are likely to adopt this strategy if it proves successful.
Index fund wars
Fidelity, Schwab and Vanguard have been engaged in cost reduction wars on competing index funds for years. Investors in these funds have benefited as the expense ratios of popular index funds have plummeted.
As mentioned above, Fidelity has taken the bold step of going all the way to a zero expense ratio on a new class of index funds.
Will more zero expense ratio ETFs and mutual funds become available in the future? It seems very likely.
Are more ETFs and mutual funds with negative expense ratios possible as well? I think so.
How asset managers make money on zero expense ratio funds
You may wonder how mutual fund companies can make money on zero expense ratio or negative expense ratio ETFs and mutual funds.
Through a process called securities lending, asset managers are able to generate revenue, sometimes even in excess of the expense ratios of the funds. Securities lending involves asset managers lending securities they hold to short-sellers for a fee.
As Sommer outlines in his article, the Fidelity Small Cap Index Fund is able to generate 0.200% in securities lending revenue, which more than covers the fund’s expense ratio of 0.025%. Right now, the fund is still charging an expense ratio, but it is clear that enough revenue exists for this fund to either move to a zero or negative expense ratio.
Mutual funds and ETFs on sale
Mutual funds and ETFs that have zero or negative expense ratios may not be cost-free forever.
It appears that asset managers will be using negative expense ratios for new mutual fund offerings to build scale quickly. Attracting significant assets to a fund within a short period is vital to achieving profitability.
Not necessarily good investments
As you think about investing in funds that have zero or negative cost, you shouldn’t give too much weight to the cost element in your evaluation process. While a factor, cost should never be the main driver of your investment strategy.
You still need to choose solid managers of funds that have risk profiles and investment objectives that are appropriate for your age and investment goals.
Just because an investment option has a low or negative cost does not necessarily mean that it is a good investment or appropriate for you to invest in.
This is not investment advice
None of the investment options discussed in this post should be considered investment recommendations.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or firstname.lastname@example.org.
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or email@example.com or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice, and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.