The hidden cost of Fidelity’s ZERO funds

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danielc
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The hidden cost of Fidelity’s ZERO funds

Post by danielc » Wed Nov 06, 2019 5:35 pm

I came across an interesting article today:

FZROX vs VTSAX: The hidden cost of Fidelity’s zero fee index funds

The point is quite straight forward: Vanguard's VTSAX pays dividends quarterly and Fidelity's FZROX pays dividends yearly. The lost growth due to less frequent reinvestment of dividends is several times larger than the ER of Vanguard's fund. The article has a link to a spreadsheet. Using the last 40 years of S&P 500 it estimates that the total cost of VTSAX is 0.07% (of which 0.04% is ER) and FZROX is 0.15% (of which 0% is ER). So assuming that you care about a 0.08% difference, you really will make more money with VTSAX.

I took their spreadsheet and added columns for Fidelity's regular total market fund, FSKAX. That fund distributes dividends twice a year and has an ER of 0.015% and distributes dividends twice a year. As you might guess, it sits between VTSAX and FZROX:

Code: Select all

        ER       Total Inefficiency
VTSAX   0.040%   0.074%
FSKAX   0.015%   0.139%
FZROX   0.000%   0.146%
I thought that was interesting.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by dogagility » Wed Nov 06, 2019 5:39 pm

Only a short time frame, but what is the total return of FZROX vs VTSAX since inception of FZROX?
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Re: The hidden cost of Fidelity’s ZERO funds

Post by Jack FFR1846 » Wed Nov 06, 2019 5:42 pm

I hold VTI but didn't include it when I spent a complete year to compare equal investments (mine) in
FZROX and FSKAX.

What I found in real life, easy to look at my account and compare is that at the end of the year, FZROX clearly returned more, as in that had more in it. I then sold my position in FSKAX and went all FZROX.

Perhaps I should set my position in VTI to equal FZROX and take a year to compare.

I'm not a big fan of numbers that say something is more or less efficient or that something makes up for the ER by making more money. Plop down money in the 2 to compare and let them go for a year (or some other time period of choice).
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Re: The hidden cost of Fidelity’s ZERO funds

Post by retired@50 » Wed Nov 06, 2019 5:47 pm

The article makes me glad I chose Vanguard back in 1998 when I got serious about saving. I've been enjoying low expense ratios for over 20 years. :D

Regards,

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Re: The hidden cost of Fidelity’s ZERO funds

Post by Nate79 » Wed Nov 06, 2019 5:48 pm

It's amazing what level of stupidity can be published online these days.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by rkhusky » Wed Nov 06, 2019 5:49 pm

danielc wrote:
Wed Nov 06, 2019 5:35 pm
The point is quite straight forward: Vanguard's VTSAX pays dividends quarterly and Fidelity's FZROX pays dividends yearly. The lost growth due to less frequent reinvestment of dividends is several times larger than the ER of Vanguard's fund.
But the stock fund NAV drops when a dividend is paid, such that you have as much money before and after the payment of a stock dividend. So, not seeing how the delay of dividends affects the total return of a stock fund.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by Svensk Anga » Wed Nov 06, 2019 5:50 pm

I think the argument is not valid. If Fido does not pay out a dividend quarterly, the money stays in the fund as part of its NAV. It is presumably reinvested within the fund in line with its index tracking investments. The dividend cash is not held in limbo elsewhere. Taking cash out of the fund, paying it to the individual investors then having them reinvest in the fund winds up as no net change except it incurs administrative costs. Keeping those administrative costs down helps Fido hold the zero ER.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by danielc » Wed Nov 06, 2019 5:53 pm

rkhusky wrote:
Wed Nov 06, 2019 5:49 pm
But the stock fund NAV drops when a dividend is paid, such that you have as much money before and after the payment of a stock dividend. So, not seeing how the delay of dividends affects the total return of a stock fund.
Hmm... I should have thought of that. Now I think the article is wrong.

But that does raise a question: Where DO mutual fund companies hold dividends before they pay them out? Does paying out dividends less often translate into a form of cash drag?

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Re: The hidden cost of Fidelity’s ZERO funds

Post by rkhusky » Wed Nov 06, 2019 6:02 pm

danielc wrote:
Wed Nov 06, 2019 5:53 pm
But that does raise a question: Where DO mutual fund companies hold dividends before they pay them out? Does paying out dividends less often translate into a form of cash drag?
Not sure where they are held. Perhaps the fund accrues more interest by holding on to the dividends. (edit: Perhaps the stock dividends are reinvested in the stock that issued the dividend, such that the total value of that stock does not change, since its stock price should drop after the dividend is paid. Or perhaps the fund manager uses the dividends to manage inflows/outflows more efficiently)

I recall a thread where the actual mechanism for the NAV drop was discussed. If I recall correctly, it was sort of an emergent behavior of the market that caused the NAV (or stock price) to increase before the dividend was due to be paid and then dropping down to the pre-dividend level after the payment. There was no entity, like the fund manager or brokerage, that stipulated the NAV (or stock price) decrease.
Last edited by rkhusky on Wed Nov 06, 2019 6:08 pm, edited 2 times in total.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by nisiprius » Wed Nov 06, 2019 6:03 pm

The blog posting says
That means FZROX (and SWTSX) are sitting on dividends for up to a year before releasing that cash to the investor.
I don't think so. I think that's nonsense. It's not "sitting on them" in the sense of holding them in cash, in some way that benefits Fidelity at the expense of fund shareholders. It just means that Fidelity is reinvesting them... continously, as they come in... rather than giving you, the investor, three quarterly oppotunities per year not to reinvest them, or to reinvest them somewhere else.

We can verify this in two ways. If Fidelity were "sitting on" those dividends, then, now being close to the end of the year, Morningstar should show FZROX as holding more in cash than VTSAX. In fact, FZROX is "sitting on" considerably less cash than VTSAX.

Image

Second, if this were a problem we should care about, it ought to show up in the form of lower performance for FZROX. Conversely, if the "higher" expense ratio for VTSAX were a problem, it ought to show up in the form of lower performance for VTSAX, to the extent of $4 a year on a $10,000 investment. I'm going to cheat just a little on the endpoints because as is often the case there is some sort of glitch in the first day or two of FZROX, so instead of starting at 8/2/2018, the inception of FZROX, I'm going to start two days later, at 8/4/2018.

Source

Image

The actual results is that after the first couple of days, the two funds matched each other with spectacular precision. And whatever the supposed analysis--bogus, I'm pretty sure--of the effect of "sitting on" dividends, nevertheless the result is that in about a year of operation, FZROX came out ahead by $28.43.
Last edited by nisiprius on Wed Nov 06, 2019 8:50 pm, edited 2 times in total.
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Re: The hidden cost of Fidelity’s ZERO funds

Post by retired@50 » Wed Nov 06, 2019 6:04 pm

Svensk Anga wrote:
Wed Nov 06, 2019 5:50 pm
I think the argument is not valid. If Fido does not pay out a dividend quarterly, the money stays in the fund as part of its NAV. It is presumably reinvested within the fund in line with its index tracking investments. The dividend cash is not held in limbo elsewhere. How would anyone know this for certain? Taking cash out of the fund, paying it to the individual investors then having them reinvest in the fund winds up as no net change except it incurs administrative costs. Keeping those administrative costs down helps Fido hold the zero ER.
I wonder if this is accurate or not... It's not really Fido paying the dividend, it's all the individual companies that the fund owns. They remit the dividend to Fido, and then Fido does what?

They could reinvest it right away in the stocks within the index fund
-OR-
They could do something else... If they invested it right away in stocks in the index fund, then I wouldn't expect the inefficiency difference shown.
Sort of makes you wonder...???
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Re: The hidden cost of Fidelity’s ZERO funds

Post by illumination » Wed Nov 06, 2019 6:08 pm

Where do the paid dividends "wait" for the year?

A dividend compounding annually versus quarterly or monthly (at the same APR) does make a real difference in total return over a long time frame. Just playing around with some variables.

https://www.moneycalculator.org/CompoundInterest/

Maybe I am misunderstanding the mutual fund structure?

If it's all the same, why don't other mutual funds just pay their dividends yearly?

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Re: The hidden cost of Fidelity’s ZERO funds

Post by mervinj7 » Wed Nov 06, 2019 6:09 pm

danielc wrote:
Wed Nov 06, 2019 5:53 pm
rkhusky wrote:
Wed Nov 06, 2019 5:49 pm
But the stock fund NAV drops when a dividend is paid, such that you have as much money before and after the payment of a stock dividend. So, not seeing how the delay of dividends affects the total return of a stock fund.
Hmm... I should have thought of that. Now I think the article is wrong.

But that does raise a question: Where DO mutual fund companies hold dividends before they pay them out? Does paying out dividends less often translate into a form of cash drag?
I've argued with this particular author before. If you are interested in the comments the first time he posted this, check out the reddit post below. In the end, he completely ignored all the comments and feedback and choose to publish it on his blog anyway. My mind is boggled...

https://www.reddit.com/r/investing/comm ... re_likely/

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Re: The hidden cost of Fidelity’s ZERO funds

Post by Svensk Anga » Wed Nov 06, 2019 6:10 pm

danielc wrote:
Wed Nov 06, 2019 5:53 pm

But that does raise a question: Where DO mutual fund companies hold dividends before they pay them out? Does paying out dividends less often translate into a form of cash drag?
Dividends are held as part of the fund's assets. Probably some in stocks, some in cash. Vanguard total stock held 0.72% of assets in cash as of 9/30/2019 (see: http://portfolios.morningstar.com/fund/summary?t=vtsax ) Dividends were paid in mid-September, so this is after paying out. I am not going to worry about the drag of 0.72% cash in this fund. They have to keep some on hand to meet redemptions. If you are really concerned, you might track the cash numbers of the various index fund providers to see which stay more fully invested. Or, just bump up your equity allocation to account for the 0.72% cash.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by Svensk Anga » Wed Nov 06, 2019 6:13 pm

illumination wrote:
Wed Nov 06, 2019 6:08 pm

If it's all the same, why don't other mutual funds just pay their dividends yearly?
I think it is because a large subset of investors like to have the dividend cash flow quarterly (or even monthly). The fund companies respond to customers' desires in a competitive market.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by rkhusky » Wed Nov 06, 2019 6:14 pm

illumination wrote:
Wed Nov 06, 2019 6:08 pm
If it's all the same, why don't other mutual funds just pay their dividends yearly?
Bond funds typically pay dividends monthly. But in this case sitting on dividends would hurt the investor.

Perhaps Vanguard pays quarterly to smooth out distributions. Quarterly payment reduces the penalty for "buying the dividend" when purchasing a stock fund in a taxable account just before the dividend is paid out. Hence it might reduce the increase in purchases just after the dividend is paid, which normally takes place right at the end of the year for yearly dividends, when a lot of other stuff is going on. Also, it makes tax planning easier if you don't have to guess about a big dividend paid out right at the end of the year, when people might be on vacation.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by retired@50 » Wed Nov 06, 2019 6:18 pm

nisiprius wrote:
Wed Nov 06, 2019 6:03 pm
I don't think so. I think that's nonsense. "That means FZROX (and SWTSX) are sitting on dividends for up to a year before releasing that cash to the investor." It's not "sitting on them" in the sense of holding them in cash, in some way that benefits Fidelity at the expense of fund shareholders. It just means that Fidelity is reinvesting them... continously, as they come in... rather than giving you, the investor, three quarterly oppotunities per year not to reinvest them, or to reinvest them somewhere else.

We can verify this in two ways. If Fidelity were "sitting on" those dividends, then, now being close to the end of the year, Morningstar should show FZROX as holding more in cash than VTSAX. In fact, FZROX is "sitting on" considerably less cash than VTSAX.

Image

Second, if this were a problem we should care about, it ought to show up in the form of lower performance for FZROX. Conversely, if the "higher" expense ratio for VTSAX were a problem, it ought to show up in the form of lower performance for VTSAX, to the extent of $4 a year on a $10,000 investment. I'm going to cheat just a little on the endpoints because as is often the case there is some sort of glitch in the first day or two of FZROX, so instead of starting at 8/2/2018, the inception of FZROX, I'm going to start two days later, at 8/4/2018.

Source

Image

The actual results is that after the first couple of days, the two funds matched each other with spectacular precision. And whatever the supposed analysis--bogus, I'm pretty sure--of the effect of "sitting on" dividends, nevertheless the result is that in about a year of operation, FZROX came out ahead by $28.43.
These graphics make me think about a couple of different things...
The FZROX fund holds around 2500 stocks, and has about $4 billion in total assets.
The VTSAX fund holds around 3600 stocks and has $827 billion in total with $233 billion in Admiral shares.

I'd imagine that the daily inflows/outflows of these two funds are very different, and thus the management of them presents different challenges. Just the differences in the stock holdings could easily explain the performance differences.

Regards,

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Re: The hidden cost of Fidelity’s ZERO funds

Post by danielc » Wed Nov 06, 2019 7:19 pm

mervinj7 wrote:
Wed Nov 06, 2019 6:09 pm
danielc wrote:
Wed Nov 06, 2019 5:53 pm
Hmm... I should have thought of that. Now I think the article is wrong.

But that does raise a question: Where DO mutual fund companies hold dividends before they pay them out? Does paying out dividends less often translate into a form of cash drag?
I've argued with this particular author before. If you are interested in the comments the first time he posted this, check out the reddit post below. In the end, he completely ignored all the comments and feedback and choose to publish it on his blog anyway. My mind is boggled...

https://www.reddit.com/r/investing/comm ... re_likely/
Wow... Thanks for linking that. And sorry for accidentally spreading misinformation.

EDIT: In that thread, the poster says "If you look at the spreadsheet, I think you'll see this actually does assume all cash inside the fund is reinvested." ---- Clearly this person doesn't know how his own spreadsheet works (I looked at his spreadsheet).

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Re: The hidden cost of Fidelity’s ZERO funds

Post by SeeMoe » Wed Nov 06, 2019 8:19 pm

Hmmmm. Maybe this helps explain the FORBES blurb that I found when asking the web about the owners of Fido. It’s said, as I recall, that 4 of the family members have a net worth of $38 billion dollars! Of course the family has owned Fido since it’s founding in 1946.

Moe.. :oops:
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Re: The hidden cost of Fidelity’s ZERO funds

Post by Grt2bOutdoors » Wed Nov 06, 2019 8:44 pm

Jack FFR1846 wrote:
Wed Nov 06, 2019 5:42 pm
I hold VTI but didn't include it when I spent a complete year to compare equal investments (mine) in
FZROX and FSKAX.

What I found in real life, easy to look at my account and compare is that at the end of the year, FZROX clearly returned more, as in that had more in it. I then sold my position in FSKAX and went all FZROX.

Perhaps I should set my position in VTI to equal FZROX and take a year to compare.

I'm not a big fan of numbers that say something is more or less efficient or that something makes up for the ER by making more money. Plop down money in the 2 to compare and let them go for a year (or some other time period of choice).
When looking at the two Fidelity funds in portfolio visualizer, the monthly returns are all over the map, some months FZROX earns less, but lately it has been earning more when compared to FSKAX. Any idea why?
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Re: The hidden cost of Fidelity’s ZERO funds

Post by nedsaid » Wed Nov 06, 2019 8:46 pm

Looks to me that the ZERO Funds are the real deal, they are doing what Fidelity said they would do, tracking their indexes. These funds are ZERO enough for me, somehow I don't have the mental picture of Fidelity Executives in a secret room sitting on top of a pile of money from the "hidden fees" in their ZERO funds. Don't own any of these yet but I might someday. We will see.
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Re: The hidden cost of Fidelity’s ZERO funds

Post by Northern Flicker » Wed Nov 06, 2019 8:56 pm

dogagility wrote:
Wed Nov 06, 2019 5:39 pm
Only a short time frame, but what is the total return of FZROX vs VTSAX since inception of FZROX?
Mutual fund providers can take more securities lending risk by doing more lending to generate additional revenue, or take less securities lending risk by doing less lending to generate less revenue. You would need to subtract securities lending revenue from the returns to do a comparison that would shed some light in cost differences.
Index fund investor since 1987.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by regularguy455 » Wed Nov 06, 2019 10:01 pm

The more important issue is tax skill and tracking error. I posted a thread on this over a year ago: viewtopic.php?t=250988

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Re: The hidden cost of Fidelity’s ZERO funds

Post by Tdubs » Wed Nov 06, 2019 10:32 pm

retired@50 wrote:
Wed Nov 06, 2019 6:18 pm
nisiprius wrote:
Wed Nov 06, 2019 6:03 pm
I don't think so. I think that's nonsense. "That means FZROX (and SWTSX) are sitting on dividends for up to a year before releasing that cash to the investor." It's not "sitting on them" in the sense of holding them in cash, in some way that benefits Fidelity at the expense of fund shareholders. It just means that Fidelity is reinvesting them... continously, as they come in... rather than giving you, the investor, three quarterly oppotunities per year not to reinvest them, or to reinvest them somewhere else.

We can verify this in two ways. If Fidelity were "sitting on" those dividends, then, now being close to the end of the year, Morningstar should show FZROX as holding more in cash than VTSAX. In fact, FZROX is "sitting on" considerably less cash than VTSAX.

Image

Second, if this were a problem we should care about, it ought to show up in the form of lower performance for FZROX. Conversely, if the "higher" expense ratio for VTSAX were a problem, it ought to show up in the form of lower performance for VTSAX, to the extent of $4 a year on a $10,000 investment. I'm going to cheat just a little on the endpoints because as is often the case there is some sort of glitch in the first day or two of FZROX, so instead of starting at 8/2/2018, the inception of FZROX, I'm going to start two days later, at 8/4/2018.

Source

Image

The actual results is that after the first couple of days, the two funds matched each other with spectacular precision. And whatever the supposed analysis--bogus, I'm pretty sure--of the effect of "sitting on" dividends, nevertheless the result is that in about a year of operation, FZROX came out ahead by $28.43.
These graphics make me think about a couple of different things...
The FZROX fund holds around 2500 stocks, and has about $4 billion in total assets.
The VTSAX fund holds around 3600 stocks and has $827 billion in total with $233 billion in Admiral shares.

I'd imagine that the daily inflows/outflows of these two funds are very different, and thus the management of them presents different challenges. Just the differences in the stock holdings could easily explain the performance differences.

Regards,
Does FZROX just hold fewer small caps and has a tilt?

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Re: The hidden cost of Fidelity’s ZERO funds

Post by AlohaJoe » Wed Nov 06, 2019 10:52 pm

danielc wrote:
Wed Nov 06, 2019 5:53 pm
Does paying out dividends less often translate into a form of cash drag?
Not really. (But you can check by seeing how the fund tracks against its index.) Most funds will hold cash but then buy futures & derivates to offset the cash drag. Taking a look at Vanguard's TSM as an example:

It the annual report they held 0.9% in cash (Vanguard Market Liquidity Fund), about $5.6 billion. But they also have $3.7 billion of E-mini S&P 500 futures. $129 million of Russell 2000 futures. $40 million of S&P Mid-Cap 400 index futures. $70 million of swaps from SLM and VICI (that are paying 3.2%).

When you add it all up Vanguard tells you

"The fund invests a portion of its cash reserves in equity markets through the use of index futures contracts and swap contracts. After giving effect to futures and swap investments, the fund’s effective common stock and temporary cash investment positions represent 100.0% and 0.3%, respectively, of net assets."

Don't tell the leverage haters that if you buy VTSAX you are leveraging your investment by 0.3% :twisted:

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Re: The hidden cost of Fidelity’s ZERO funds

Post by BigPrince » Wed Nov 06, 2019 11:36 pm

danielc wrote:
Wed Nov 06, 2019 5:53 pm
rkhusky wrote:
Wed Nov 06, 2019 5:49 pm
But the stock fund NAV drops when a dividend is paid, such that you have as much money before and after the payment of a stock dividend. So, not seeing how the delay of dividends affects the total return of a stock fund.
Hmm... I should have thought of that. Now I think the article is wrong.

But that does raise a question: Where DO mutual fund companies hold dividends before they pay them out? Does paying out dividends less often translate into a form of cash drag?
Most Vanguard funds use Vanguard Market Liquidity Fund and/or Vanguard Municipal Cash Management Fund.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by alex_686 » Thu Nov 07, 2019 10:05 am

Hey! I have been invited to comment on this thread. I used to work in mutual fund administration in accounting. The theory behind this is bunk.

Cash management is a core utility function of funds and everybody that I know that does this tries really hard to keep "Cash Drag" of performance to a minimum. When cash comes in it is reinvested as quickly as possible. This is doubly true for index funds, because indexes exist in fairy land and don't have to worry about cash, buying fraction shares, or redemptions. Any cash held is going to cause tracking error.

If dividends don't matter for stocks, this is doubly true for funds. You can track a index, a index fund, and a index CIT and they should track.

Dividend distributions are driven by the need for the fund to generate "reportable transactions" so a 1099 can be generated. This so you can pay the correct amount of taxes. Funds would rather not do distributions.

What happens when a stock pays a dividend to a fund? The funds records the accrual as income, as it sits in a income ledger. Note, this is a Income Statement operation. Then cash is received as a asset. Fund managers reinvest that. Note, this is a Balance Sheet operations.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by Jack FFR1846 » Thu Nov 07, 2019 10:10 am

Grt2bOutdoors wrote:
Wed Nov 06, 2019 8:44 pm
Jack FFR1846 wrote:
Wed Nov 06, 2019 5:42 pm
I hold VTI but didn't include it when I spent a complete year to compare equal investments (mine) in
FZROX and FSKAX.
What I found in real life, easy to look at my account and compare is that at the end of the year, FZROX clearly returned more, as in that had more in it. I then sold my position in FSKAX and went all FZROX.

Perhaps I should set my position in VTI to equal FZROX and take a year to compare.

I'm not a big fan of numbers that say something is more or less efficient or that something makes up for the ER by making more money. Plop down money in the 2 to compare and let them go for a year (or some other time period of choice).

When looking at the two Fidelity funds in portfolio visualizer, the monthly returns are all over the map, some months FZROX earns less, but lately it has been earning more when compared to FSKAX. Any idea why?

They track different indexes. I watched my 2 balances for a year. Honestly, I don't care why the Zero fund does better. I just boarded that train and pulled over the rest of my money.
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Re: The hidden cost of Fidelity’s ZERO funds

Post by greg24 » Thu Nov 07, 2019 10:27 am

If the dividend just lowers the NAV, why do index funds pay dividends?

They could just retain all dividends and be more tax-efficient.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by Mountain Doc » Thu Nov 07, 2019 10:38 am

greg24 wrote:
Thu Nov 07, 2019 10:27 am
If the dividend just lowers the NAV, why do index funds pay dividends?

They could just retain all dividends and be more tax-efficient.
That would be great for investors, bad for the tax man. The law requires mutual funds to distribute the underlying dividends.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by alex_686 » Thu Nov 07, 2019 10:42 am

Mountain Doc wrote:
Thu Nov 07, 2019 10:38 am
greg24 wrote:
Thu Nov 07, 2019 10:27 am
If the dividend just lowers the NAV, why do index funds pay dividends?

They could just retain all dividends and be more tax-efficient.
That would be great for investors, bad for the tax man. The law requires mutual funds to distribute dividends.
To extend, if mutual funds did not distribute taxable income then one could avoid taxes. Would that be fair? Investor #1 holds the equities directly and has to pay tax while investor #2 holds them indirect and does not pay tax? No, it would not.

Taxes should be equitable and transparent. Loopholes should be discouraged. If you want to go down this path then you should argue for the elimination of income taxes.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by TSR » Thu Nov 07, 2019 10:52 am

It would seem that the easiest way to test this would be to compare these funds to the TSP C fund, which tracks the S&P 500 but NEVER pays a dividend! Surely that means they're robbing us blind, right?

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Re: The hidden cost of Fidelity’s ZERO funds

Post by rkhusky » Thu Nov 07, 2019 11:19 am

TSR wrote:
Thu Nov 07, 2019 10:52 am
It would seem that the easiest way to test this would be to compare these funds to the TSP C fund, which tracks the S&P 500 but NEVER pays a dividend! Surely that means they're robbing us blind, right?
Dividends are included in C Fund share price.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by abuss368 » Thu Nov 07, 2019 11:21 am

danielc wrote:
Wed Nov 06, 2019 5:35 pm
I came across an interesting article today:

FZROX vs VTSAX: The hidden cost of Fidelity’s zero fee index funds

The point is quite straight forward: Vanguard's VTSAX pays dividends quarterly and Fidelity's FZROX pays dividends yearly. The lost growth due to less frequent reinvestment of dividends is several times larger than the ER of Vanguard's fund. The article has a link to a spreadsheet. Using the last 40 years of S&P 500 it estimates that the total cost of VTSAX is 0.07% (of which 0.04% is ER) and FZROX is 0.15% (of which 0% is ER). So assuming that you care about a 0.08% difference, you really will make more money with VTSAX.

I took their spreadsheet and added columns for Fidelity's regular total market fund, FSKAX. That fund distributes dividends twice a year and has an ER of 0.015% and distributes dividends twice a year. As you might guess, it sits between VTSAX and FZROX:

Code: Select all

        ER       Total Inefficiency
VTSAX   0.040%   0.074%
FSKAX   0.015%   0.139%
FZROX   0.000%   0.146%
I thought that was interesting.
This is really good and thanks for sharing. I guess that could work two ways correct? Reinvesting dividends quarterly (in place of annually) in a down market could accelerate losses but one is reinvesting and lowering cost basis.
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Re: The hidden cost of Fidelity’s ZERO funds

Post by abuss368 » Thu Nov 07, 2019 11:22 am

I have always thought if Vanguard will ever end up paying dividends each month (instead of quarterly or yearly)?
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Re: The hidden cost of Fidelity’s ZERO funds

Post by abuss368 » Thu Nov 07, 2019 11:23 am

I would expect and hope that Fidelity would disclose this in prospectus and also on the commercial that plays on television nonstop.
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Re: The hidden cost of Fidelity’s ZERO funds

Post by alex_686 » Thu Nov 07, 2019 11:30 am

abuss368 wrote:
Thu Nov 07, 2019 11:21 am
This is really good and thanks for sharing. I guess that could work two ways correct? Reinvesting dividends quarterly (in place of annually) in a down market could accelerate losses but one is reinvesting and lowering cost basis.
No. Dividends payments are reinvested back into the fund. There is no economic impact. Distributions are strictly to generate reportable tax events for your 1099.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by alex_686 » Thu Nov 07, 2019 11:32 am

abuss368 wrote:
Thu Nov 07, 2019 11:22 am
I have always thought if Vanguard will ever end up paying dividends each month (instead of quarterly or yearly)?
Why? Paying dividends is a drag on performance. The accounting is tricky, so extra accountants are needed. If not done correctly one could blow up the fund. Assets have to be liquidated at a unfortunate time of the year to meet the cash-outs.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by abuss368 » Thu Nov 07, 2019 11:34 am

alex_686 wrote:
Thu Nov 07, 2019 11:30 am
abuss368 wrote:
Thu Nov 07, 2019 11:21 am
This is really good and thanks for sharing. I guess that could work two ways correct? Reinvesting dividends quarterly (in place of annually) in a down market could accelerate losses but one is reinvesting and lowering cost basis.
No. Dividends payments are reinvested back into the fund. There is no economic impact. Distributions are strictly to generate reportable tax events for your 1099.
I understand that but it appears the research focuses on the timing of the reinvestment of the dividends. This the higher cost from lost returns.
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Re: The hidden cost of Fidelity’s ZERO funds

Post by alex_686 » Thu Nov 07, 2019 11:43 am

abuss368 wrote:
Thu Nov 07, 2019 11:34 am
alex_686 wrote:
Thu Nov 07, 2019 11:30 am
abuss368 wrote:
Thu Nov 07, 2019 11:21 am
This is really good and thanks for sharing. I guess that could work two ways correct? Reinvesting dividends quarterly (in place of annually) in a down market could accelerate losses but one is reinvesting and lowering cost basis.
No. Dividends payments are reinvested back into the fund. There is no economic impact. Distributions are strictly to generate reportable tax events for your 1099.
I understand that but it appears the research focuses on the timing of the reinvestment of the dividends. This the higher cost from lost returns.
That is not what the spreadsheet is showing. However, even if that were not the case and we are talking about time timing issue - still not true. Distributions and reinvestments are about changes the size of the slices of the pie - you don't actually make the pie smaller or larger. It has a accounting impact, not a economic one.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by danielc » Thu Nov 07, 2019 12:06 pm

alex_686 wrote:
Thu Nov 07, 2019 10:05 am
Hey! I have been invited to comment on this thread. I used to work in mutual fund administration in accounting. The theory behind this is bunk.

Cash management is a core utility function of funds and everybody that I know that does this tries really hard to keep "Cash Drag" of performance to a minimum. When cash comes in it is reinvested as quickly as possible. This is doubly true for index funds, because indexes exist in fairy land and don't have to worry about cash, buying fraction shares, or redemptions. Any cash held is going to cause tracking error.

If dividends don't matter for stocks, this is doubly true for funds. You can track a index, a index fund, and a index CIT and they should track.

Dividend distributions are driven by the need for the fund to generate "reportable transactions" so a 1099 can be generated. This so you can pay the correct amount of taxes. Funds would rather not do distributions.

What happens when a stock pays a dividend to a fund? The funds records the accrual as income, as it sits in a income ledger. Note, this is a Income Statement operation. Then cash is received as a asset. Fund managers reinvest that. Note, this is a Balance Sheet operations.
THANK YOU for the detailed response. This was very interesting. I regret that I accidentally spread misinformation but I'm glad that this forum turned this into a learning opportunity.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by danielc » Thu Nov 07, 2019 12:08 pm

greg24 wrote:
Thu Nov 07, 2019 10:27 am
If the dividend just lowers the NAV, why do index funds pay dividends?

They could just retain all dividends and be more tax-efficient.
It would be tax-efficient in the sense that it would be tax fraud. Funds are required to post dividends. See alex_686's response.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by nisiprius » Thu Nov 07, 2019 12:09 pm

danielc wrote:
Thu Nov 07, 2019 12:06 pm
...THANK YOU for the detailed response. This was very interesting. I regret that I accidentally spread misinformation but I'm glad that this forum turned this into a learning opportunity...
It often does. As an old Internet saying goes--"Ward Cunningham's Law"--"The best way to get the right answer on the Internet is not to ask a question, it's to post the wrong answer."
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Re: The hidden cost of Fidelity’s ZERO funds

Post by danielc » Thu Nov 07, 2019 12:10 pm

abuss368 wrote:
Thu Nov 07, 2019 11:21 am
This is really good and thanks for sharing. I guess that could work two ways correct? Reinvesting dividends quarterly (in place of annually) in a down market could accelerate losses but one is reinvesting and lowering cost basis.
Please review the rest of this thread. The article I linked to was 100% wrong. I especially recommend reading alex_686's explanation

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Re: The hidden cost of Fidelity’s ZERO funds

Post by White Coat Investor » Thu Nov 07, 2019 12:22 pm

danielc wrote:
Wed Nov 06, 2019 5:35 pm
I came across an interesting article today:

FZROX vs VTSAX: The hidden cost of Fidelity’s zero fee index funds

The point is quite straight forward: Vanguard's VTSAX pays dividends quarterly and Fidelity's FZROX pays dividends yearly. The lost growth due to less frequent reinvestment of dividends is several times larger than the ER of Vanguard's fund. The article has a link to a spreadsheet. Using the last 40 years of S&P 500 it estimates that the total cost of VTSAX is 0.07% (of which 0.04% is ER) and FZROX is 0.15% (of which 0% is ER). So assuming that you care about a 0.08% difference, you really will make more money with VTSAX.

I took their spreadsheet and added columns for Fidelity's regular total market fund, FSKAX. That fund distributes dividends twice a year and has an ER of 0.015% and distributes dividends twice a year. As you might guess, it sits between VTSAX and FZROX:

Code: Select all

        ER       Total Inefficiency
VTSAX   0.040%   0.074%
FSKAX   0.015%   0.139%
FZROX   0.000%   0.146%
I thought that was interesting.
If there is a hidden cost, it'll show up in the returns. I think there may very well be one, but it's certainly less than 5 basis points. VTSAX is up 24.11% YTD. FZROX is up 24.49%. Doesn't look like much of a hidden cost to me!

I actually own both, including in the same account in my HSA for historical reasons (transferred VTI in kind from HSA Bank/TDA to Fidelity), and consider them equivalent.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Re: The hidden cost of Fidelity’s ZERO funds

Post by lukestuckenhymer » Thu Nov 07, 2019 12:48 pm

alex_686 wrote:
Thu Nov 07, 2019 11:32 am
abuss368 wrote:
Thu Nov 07, 2019 11:22 am
I have always thought if Vanguard will ever end up paying dividends each month (instead of quarterly or yearly)?
Why? Paying dividends is a drag on performance. The accounting is tricky, so extra accountants are needed. If not done correctly one could blow up the fund. Assets have to be liquidated at a unfortunate time of the year to meet the cash-outs.
If I was running a fund, I'd want to distribute dividends once a year for this reason. But I rather do like getting dividends quarterly instead of annually.
Either way, this has such a negligible effect on returns that I don't believe it's worth mentioning. However, what I'm more concerned about is Capital Gains distributions, which FZROX distributes once a year as well. This makes FZROX less tax efficient than VTSAX.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by alex_686 » Thu Nov 07, 2019 12:57 pm

lukestuckenhymer wrote:
Thu Nov 07, 2019 12:48 pm
alex_686 wrote:
Thu Nov 07, 2019 11:32 am
Either way, this has such a negligible effect on returns that I don't believe it's worth mentioning. However, what I'm more concerned about is Capital Gains distributions, which FZROX distributes once a year as well. This makes FZROX less tax efficient than VTSAX.
I am not following at all, and I can't think of any angle of method where this would be true. Could you please expand on this please?

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Re: The hidden cost of Fidelity’s ZERO funds

Post by Makefile » Thu Nov 07, 2019 1:23 pm

alex_686 wrote:
Thu Nov 07, 2019 12:57 pm
I am not following at all, and I can't think of any angle of method where this would be true. Could you please expand on this please?
I think that is a reference to the fact that Vanguard avoids making capital gain distributions at all due to the ability to "export" them to the ETF shares, not the fact of whether capital gains are annual or more frequent.

I did have one thought though that maybe you can answer, alex_686. I wonder if mutual fund companies know and keep statistics on what percent of shares are set to reinvest dividends versus take them as cash. It seems the higher that percentage is, the more aggressive the fund could be at reinvesting dividends as soon as they come in vs. keeping a reserve to make cash distributions. Would the fact that FZROX can only be held at Fidelity help them in that regard in knowing that information?

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Re: The hidden cost of Fidelity’s ZERO funds

Post by DaftInvestor » Thu Nov 07, 2019 1:28 pm

Thanks to nisiprius for pointing out the true facts.

This article seems to simply be yet another Vanguard-Fan's attempt to de-throne Fidelity's win in having the lowest ERs.

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Re: The hidden cost of Fidelity’s ZERO funds

Post by alex_686 » Thu Nov 07, 2019 1:35 pm

Makefile wrote:
Thu Nov 07, 2019 1:23 pm
I did have one thought though that maybe you can answer, alex_686. I wonder if mutual fund companies know and keep statistics on what percent of shares are set to reinvest dividends versus take them as cash. It seems the higher that percentage is, the more aggressive the fund could be at reinvesting dividends as soon as they come in vs. keeping a reserve to make cash distributions. Would the fact that FZROX can only be held at Fidelity help them in that regard in knowing that information?
This is known information, it does not matter where the funds are held or what the networking level is. This is part of cash management, which includes purchases, redemenations, exchanges, dividend payments, etc.

The percentage really does not matter too much. Yes, having a high percentage of funds set to redeem is ticker for the cash management side, but not massively so. The market is pretty liquid and deep in the large cap space so a fund should be able to raise the cash easily. I little extra scrambling for the assistant portfolio managers but nothing that would impact returns much.

I would guess that FZROX has to struggle a little bit. It has not ETF counterparts. It is small and young, which implies a fairly homogeneous investor preferences, so a similar pattern of investment and withdraws. Heterogeneous is better - the behaviors of different types of clients tend to offset.

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