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FZROX vs. VTI: Does Fidelity's 0% Fee Total Market Fund Beat Vanguard?

I choose ETFs over mutual funds for building out your portfolio, but FZROX might be the one mutual fund out there that I think is worthy of consideration.

When it comes to constructing a portfolio, the core of it should be, well, boring! By "boring", I mean broadly diversified, plain vanilla and ultra-low cost. If you're shopping in the ETF marketplace, it shouldn't be too difficult to find several that fit the bill. Today, there are around 70 different ETFs that charge 0.05% or less annually to own, so investors today have plenty of options that fit the "ultra-low cost" definition.

For a pure core portfolio holding, it's tough to find a fund that works better than the Vanguard Total Stock Market ETF (VTI). It holds nearly 4,000 U.S. stocks across large-, mid- and small-caps and comes with a scant 0.03% expense ratio. That's right. You'll pay just $3 a year per every $10,000 invested for full exposure to the entire U.S. stock market.

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For a number of reasons, I choose ETFs over mutual funds for building out your portfolio, but there is still one mutual fund out there that I think may be worthy of consideration - the Fidelity ZERO Total Market Index Fund (FZROX).

FZROX vs. VTI

The Fidelity vs. Vanguard battle has been raging for years. There companies were the two fund heavyweights for a long time before the ETF boom happened and names, such as BlackRock and State Street, emerged as major issuers. Vanguard is still a leader in both mutual funds and ETFs. Fidelity is still a major player on the fund side, but got a late start into ETFs. The company has yet to launch an S&P 500 or total stock market ETF, but it does offer a growing lineup of sector, thematic and smart beta ETFs that have grown it to the 14th largest ETF issuer with just over $30 billion in assets.

Fidelity launched the ZERO lineup of funds back in late 2018. In addition to FZROX, there are the Fidelity ZERO Extended Market Index Fund (FZIPX), the Fidelity ZERO Large Cap Index Fund (FNILX) and the Fidelity ZERO International Index Fund (FZILX). Collectively, the foursome has more than $20 billion in assets under management with FZROX accounting for more than half.

Your answer as to why Fidelity would launch mutual funds and take zero fees on them is a business one. It's using the ZERO funds as loss leaders to get customers in the door and then cross-sell them other products and services, such as other funds and ETFs or advisory services.

While ETFs generally win the battle over mutual funds, the FZROX vs. VTI debate is a legitimate one. In a vacuum, both would be great core portfolio holdings, but there are other factors to consider when choosing between them, one in particular that could be a dealbreaker for Fidelity.

Let's run down the differences between the two.

Composition

VTI tracks the CRSP US Total Market Index, while FZROX benchmarks to the Fidelity U.S. Total Investable Market Index. While we could sit here and nitpick minor details, these indexes are, for all intents and purposes, essentially the same. The only noticeable difference is that FZROX holds the top 3,000 names by market cap, whereas VTI holds around 4,000. Those bottom 1,000 names are such a small part of the index that they're virtually inconsequential.

There's effectively no difference between the two and their correlations should be near 100%. The difference in year-to-date performance through September 20th is 0.01%.

Expense Ratio

As mentioned, VTI charges 0.03%, while FZROX charges nothing. While that would seemingly give the win to FZROX (and it is indeed cheaper, of course), 3 basis points is almost splitting hairs.

When judging between two funds, expense ratios and trading fees are the two most important factors I consider. The primary reason is that those are the numbers you can control. You have no control over whether the stock markets gains 30% or falls 20% in any given year, but you can control how much you pay for it. If one fund charges 0.30% annually and another charges 0.60%, in a vacuum, I'd choose the 0.30% fund because why not keep that extra 0.30% in your pocket instead of handing it over to the fund company? Again, this is in a vacuum and there are other things to consider, but you get the idea.

I think the difference in expense ratios needs to be about 15 basis points or more before it really swings the pendulum for similar strategies. 3 basis points is a pretty negligible difference for a total stock market fund, but Fidelity does get the slight advantage.

Tradeability

Here's one of the big differences between mutual funds and ETFs.

ETFs are traded throughout the day and, in the case of VTI, traded quite frequently. That gives investors the ability to transact on their portfolios as conditions change and, since spreads on heavily-traded securities are so tight, there's almost no cost to trading (especially now since the major platforms, such as Vanguard, have enacted commission-free trading on most ETFs).

Mutual funds are priced only once at the end of the trading day (with a few exceptions) and can be transacted only once a day - at that day's closing price. Therefore, mutual fund investors never really know what price they're trading at and are kind of stuck if something happens in the middle of a trading day.

If you're talking about a long-term core holding in your portfolio, the ability to trade intraday may not be a big deal, but the mutual fund's inability to allow trading throughout the day gives the advantage to ETFs.

Capital Gains Distributions

Another advantage of ETFs over mutual funds is their tax efficiency. Without getting too far into the weeds on mechanics, the ETF creation/redemption mechanism allows ETFs a way to avoid booking capital gains through the redemption-in-kind feature. Thanks to this, very few ETFs ever make capital gains distributions and the ones that do should probably be avoided since it's mostly laziness on the fund manager's part that allows it.

Mutual funds, of course, make capital gains distributions quite often (although it might be less of a problem for larger, index-based, long-term buy-and-hold funds). Quite simply, the capital gains distribution makes it difficult to do any serious tax planning on non-retirement accounts and, if I'm being honest, there's no good reason why someone should be forced to pay taxes based on other people's trading activity.

The Fidelity 500 Index Fund (FXAIX) has made four separate capital gains distributions just since the beginning of 2018. Granted, these were smaller distributions, but these should be expected by mutual fund shareholders regardless of the product.

Another advantage in favor of VTI, which has not made a capital gains distribution in more than 20 years.

Broker Requirement

Here's perhaps the biggest catch for FZROX and the other Fidelity ZERO fee-free funds. You can only buy it and trade it on the Fidelity platform.

If you're an existing Fidelity brokerage account owner, this is probably a non-issue since you already have access. If you're an investor who (like me) has all of their assets at a place like Vanguard, is it worth it to open up a separate brokerage account away from the rest of your portfolio in order to save 0.03% a year? The personal answer for me is no, but each individual situation is different.

If you're someone who's willing and interested in going that extra step, there's certainly nothing wrong with going ahead and capturing that fee advantage. For some, however, the inconvenience may not be worth it.

Conclusion

If you already have an account at Fidelity and you're looking for a long-term buy-and-hold investment for your IRAs or other retirement account, I think FZROX could be the better choice. In virtually all other scenarios, I'd personally still choose VTI despite the slight cost disadvantage.

Like I mentioned, I have all of my investments at Vanguard and I'm just not interested in opening and managing a second brokerage account unless there's a significant advantage in doing so. Saving a few dollars in expenses for me doesn't qualify.

I think it's also important to consider whether you'd hold this in a retirement or taxable account. Holding FZROX in a taxable account exposes you to capital gains distribution risk and that could impact your financial planning or ability to take full advantage of compounding.

The FZROX vs. VTI debate is a prime example of why you can't make an investment decision based on one number alone. Generally speaking, lower cost is better, but there are many factors to consider in addition to expenses when deciding between one product or another.

Individual circumstances may vary, but in my personal situation, I'd still choose VTI over FZROX.

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