Yesterday Fidelity Investments dropped a challenge glove few competitors will pick up. They are offering the first commission free, management expense free, exchange traded index funds. One will duplicate the domestic total market. The other will duplicate the international stock market.
My bet is that Schwab and Vanguard will follow, but the vast majority of ETF firms will sit this price cut out.
Indeed, the real significance here may be for Fidelity Investments as a firm. The Boston-based firm was a leader and innovator in the 60’s, 70’s and well into the 80’s, but somewhere along the way it lost it’s innovative edge. Perhaps it was their enormous size. Perhaps it was Edward Johnson III, the founders’ son the innovative top dog, getting older. Whatever the reason, Fidelity Investments became far more concerned with protecting its existing territory than with opening new territory.
But with the new no-fee ETFs, Fido (as many call it) has finally embraced index investing. A stock pickers shop with an emphasis on individuality and brainpower, Fido has lived in denial about the efficacy of managed investing.
The Loser’s Game
First an idea—Charles Ellis made the announcement with “The Loser’s Game”in 1975. The notion that the vast majority of professional money managers couldn’t beat a passively managed index fund has been fought, denied and argued for more than half a century. But the evidence has long been undeniable.
Professional money management is a game of chance where the managers collect fees while the investors take the chances.
Writer Upton Sinclair explained why the industry fought the idea of index investing in a simple quote long ago.
“It is difficult to get a man to understand something when his salary depends on his not understanding it.”
This, of course, applies to all those who make their living telling people to buy this or that because it will do better than one thing or another.
So is Fidelity now on it’s way to becoming a major charity?
Not hardly.
There is money to be made in transactions, in short-term securities lending and in “order flow.” There’s also the fact that money is ‘sticky.’ People don’t move their bank or investment accounts willy-nilly. Fidelity needs to have money in accounts, even free accounts, so it will have a better shot at moving it into accounts that pay well.
After all, the best way to make money is to be near it, to be close to what Kurt Vonnegut’s Senator Rosewater called “the money river.”
Only then can you scoop some up, and drink deeply.
But what does it all mean for you and me?
Since Vanguard and Schwab already offer exchange traded funds with annual expenses below 5 basis points— that’s 5/100ths of 1 percent— there isn’t much more to be gained by being “free.” The real action has been in escaping the crushing burden of annual fees that have historically ranged from one percent a year to two percent— more if you were investing through an insurance company.
On the web:
The Loser’s Game was republished in the Financial Analysts Journal in 1995.
https://www.cfapubs.org/doi/pdf/10.2469/faj.v51.n1.1865
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
(c) Scott Burns, 2018