Low-cost index funds and exchange traded funds remain the toasts of the fund universe. Broadly speaking, that’s to the detriment of pricier actively managed mutual funds because, well, advisors and investors love a good deal.
It’s basic arithmetic. Index funds are often held by investors over long periods. The longer a fund is, the more meaningful the fee is. Specifically, the more material lower fees are. In an investment landscape awash in index funds charging just $3 or $5 annually on $10,000 investments, there’s not much reason to favor pricier strategies.
Eric McAlley, assistant teaching professor of finance at Quinnipiac University, wrote in an email to InvestorPlace: “Much can be said about the benefits of investing in index funds. … First and foremost, index funds are much lower cost relative to actively managed funds. Second, they allow investors to significantly simplify the investment process.”
Digging a little further into that first point, he wrote:
Broad market index funds carry a much lower cost relative to actively managed funds. According to Morningstar, passively managed index funds average a 0.15% expense ratio, compared to 0.67% for actively managed funds. Vanguard, considered the leader in index fund management, has an average expense ratio of 0.10%. There is a large body of research showing that, on average, passively managed index funds outperform actively managed funds in the same strategy. Much of that outperformance is attributable to the difference in fees. This cost savings is a material advantage for investors, especially when compounded over long periods of time.
In some cases, issuers don’t charge anything for index funds.
Not all index funds are free, but there are plenty of solid ideas that are accessible on the cheap.
- Fidelity ZERO Large Cap Index Fund (MUTF:FNILX)
- Schwab Small Cap Index Fund (MUTF:SWSSX)
- Vanguard Growth Index Fund (MUTF:VIGAX)
- Fidelity ZERO Extended Market Index Fund (MUTF:FZIPX)
- Invesco QQQ Trust (NASDAQ:QQQ)
- Vanguard Equity Income Fund (MUTF:VEIPX)
- Fidelity Small-Cap Growth Index Fund (MUTF:FECGX)
Fidelity ZERO Large Cap Index Fund (FNILX)
Expense ratio: 0% per yer
That’s not a typo. The Fidelity ZERO Large Cap Index Fund really doesn’t carry an expense ratio. Plus, there’s no minimum investment and no trading costs associated with this index fund, so yes, it’s free to own. Not surprisingly, investors are responsive to “free.” FNILX proves as much, as the Fidelity product has $2.42 billion in assets under management as it approaches its second birthday.
At its core, FNILX is an alternative to S&P 500 or Russell 1000 index funds that do carry fees. The Fidelity fund offers comparable exposure, that being domestic large-cap equities. Home to 516 stocks, FNILX is more comparable to an S&P 500 tracker than a total market fund. It allows easy, broad access to the markets.
Prof. McAlley wrote, “As a manager of my extended family’s retirement funds as well as my own, I know how certain retirement plans can be overrun with choices. Many retirement plans offer over 10+ stock funds to choose from. Most plans offer a broad index option (such as the S&P 500 Index) along with multiple actively managed strategies. To many investors, this makes the process overwhelming and complicated.”
Funds like this make things a lot easier on investors.
The bottom line with FNILX is that if an investor is looking to own the largest U.S. companies in basket form for the long-term, there are dozens of notable, cheap options to consider. And if this is the strategy that an investor likes, he or she should lean towards the most economical option: meaning free, when possible. Translation: FNILX is a winning idea for cost-conscious long-term investors.
Schwab Small Cap Index Fund (SWSSX)
Expense ratio: 0.04% per year
In the pantheon of issuers of cheap funds, Schwab is one of the members of the royal family. That sentiment is born out with the Schwab Small Cap Index Fund. More often than not, investors will pay a bit more for exposure to smaller stocks than to large caps, but SWSSX is, by any measure, inexpensive.
That makes SWSSX suitable for long-term investors and that’s an important consideration because small-cap stocks are usually more volatile than large-caps. That’s the trade off for accessing the higher rates of growth associated with smaller equities. Long-term is meaningful with SWSSX as the index fund produced average annual returns of 7.90% over the past 15 years.
SWSSX holds just over 2009 stocks, 14.7% of which are classified as micro-caps. Over 20% of the fund’s roster is allocated to healthcare names, while tech and consumer cyclical stocks combine for almost 27%.
Vanguard Growth Index Fund (VIGAX)
Expense ratio: 0.05% per year
The Vanguard Growth Index Fund carries a $3,000 minimum investment, but with growth equities leading the market for some time, VIGAX is worth the price of admission, particularly for investors looking to remain engaged with the fund for multiple years.
Standard growth funds, of which VIGAX is one, typically feature large allocations to some combination of the technology, consumer cyclical, and communication services sectors. That’s true of this Vanguard fund as it devotes 63.40% of its weight to technology and consumer discretionary names.
Something else to consider which is good news for those mulling VIGAX: growth stocks may not be as expensive as investors are led to believe.
“Yes, the relative multiple of high vs low Growth equities has increased but is very far from prior extremes,” notes Bernstein. “Moreover, the stocks in our sustainable growth basket trade at less than the market multiple because of the collapse in forward earnings for cyclical companies.”
Fidelity ZERO Extended Market Index Fund (FZIPX)
Expense Ratio: 0% per year
The Fidelity ZERO Extended Market Index Fund is one of four Fidelity funds that don’t sport annual expense ratios. FZIPX also dispels the notion that funds tracking smaller stocks have to be pricier than large-cap equivalents because FZIPX is free to own.
FZIPX makes for a good pairing with the aforementioned FNILX because it fills portfolio gaps created by over exposure to large-caps. In this case, “extended market” means a collection of mid- and small-cap equities that are excluded from familiar large-cap benchmarks, such as the S&P 500. That’s an expansive universe as FZIPX proves with 1,952 holdings.
FZIPX is considered a blend fund, meaning it doesn’t tilt too heavily toward either growth or value stocks. However, sourcing the index fund’s stout year-to-date performance is easy. FZIPX allocates 16.5% of its roster to healthcare stocks. The top two holdings in the fund are novel coronavirus darlings Moderna (NASDAQ:MRNA) and Teladoc (NYSE:TDOC).
Invesco QQQ (QQQ)
Expense ratio: 0.20% per year
To be clear, the Invesco QQQ is an ETF, not a traditional index fund. Regardless, this juggernaut is just too good to leave off this list jibes with the themes of cost efficiencies and accessing growth. To that point, since the end of 2018, the Nasdaq-100 Index, QQQ’s underlying benchmark, has roughly doubled, leaving the S&P 500 in the dust.
Adding to the fund’s list of superlatives, it joined the $100 billion club earlier this year. That’s an illustrious group of ETFs with a population of just five. Year-to-date, only a handful of ETFs have tacked on more new assets than QQQ. QQQ’s index tilts heavily toward tech, consumer discretionary, and communication services stocks, but that doesn’t make for a bumpier ride for investors.
For the Nasdaq-100, “one-year rolling volatility (calculated by taking the standard deviation of daily returns, annualized) was 94% correlated between Dec. 31, 2007 and June 30, 2020, when comparing the two indexes,” according to Nasdaq Global Indexes. “Given the large exposure the Nasdaq-100 has towards Technology, the ability for the Nasdaq-100 to closely track the volatility of the S&P 500 is rather impressive.”
Vanguard Equity Income Fund (VEIPX)
Expense ratio: 0.27% per year
Interest rates are at rock bottom levels and the S&P 500 has been home to rampant dividend cutting this year,. Finding steady income is taking on added importance, but the task is becoming more difficult. The Vanguard Equity Income Fund eases the burden with a high dividend focus.
“The fund’s emphasis on slower-growing, higher-yielding companies can also mean that its total return may not be as strong in a significant bull market,” according to Vanguard. “This income-focused fund may be appropriate for investors who have a long-term investment goal and a tolerance for stock market volatility.”
A primary risk with high-yield stocks is that those names may be companies in financial duress that are close to cutting or suspending payouts. Fortunately, VEIPX takes some of the risk out of that equation. The fund’s allocations to energy and real estate, high-yield sectors that are big dividend offenders this year, combine for less than 6%.
Good news part two: VEIPX has quality attributes with almost a third of its weight allocated to healthcare and consumer staples names. Second, several of VEIPX’s top 10 holdings have dividend increase streaks that are measured in decades.
Fidelity Small-Cap Growth Index Fund (FECGX)
Expense ratio: 0.05% per year
For investors that can handle the added volatility relative to traditional small-cap strategies, adding growth to the mix can handsomely pay off over the long-term. The Fidelity Small-Cap Growth Index Fund is a cost-effective avenue for accessing those benefits.
For many investors, an index fund like FECGX makes a lot of sense for tapping small-cap growth. That’s because this is an arena in which stock picking is difficult, owing to a large number of companies that are sacrificing profitability in the name of growth.
Just over a year old, FECGX is topping the category average. Individual stock risk in this index fund is low as the top 10 holdings combine for just 5.21% of the fund’s weight. Small-cap growth strategies are usually marked by overweight positions in healthcare and technology stocks. That’s true of FECGX as those sectors combine for over 54% of the index fund’s roster.
In conclusion, “… for most investors, using index funds for their longer-term investment portfolios is a prudent choice if the goal is to avoid larger costs of investing, simplifying the investment process while receiving a return that is in-line with broader markets,” wrote McAlley.
“Investors should always understand their personal risk preferences before investing in any strategy, but using this framework can greatly simplify the process without materially sacrificing return.”
On the date of publication, Todd Shriber did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Todd Shriber has been an InvestorPlace contributor since 2014.