Around 90% of stock mutual funds underperform index funds, while charging higher fees. Why would you pay more, for getting less? In this blog, you will learn all you need to know about Fidelity index fund investing! We’ll cover: What index funds are, why to choose Fidelity index funds, tips on how to create a portfolio of Fidelity index funds, how to buy Fidelity index funds.
What are index funds?
Index funds are investments of stocks or bonds that mimic the composition and performance of a market index. A common market index that you hear about in the news is the S&P 500, which is a list of 500 large U.S. companies developed by Standard and Poor. Another one is the Dow Jones Index, which is a stock market index of 30 prominent U.S. stocks.
There are index funds for small companies, for real estate stocks, etc. What makes an index fund unique is that it is passively managed. This means if I’m the fund manager of the Fidelity 500 index fund, I’m not trying to analyze each stock and pick ones that I think are going to outperform. That’s what an actively managed mutual fund does. If I’m the fund manager of the Fidelity 500 index fund, which mimics the S&P 500, I’m just going to buy the 500 stocks that comprise the S&P 500.
Why choose index funds?
You might wonder if picking individual stocks, or having someone actively manage your funds is better. Maybe you heard of someone becoming rich doing that. Maybe you look at mutual funds in your 401(k) and see some that perform quite well. So wouldn’t those be a good investment choice?
These are anecdotes. A 1 year or 3-year performance doesn’t really tell you that much. A smarter approach would be to look at a robust set of data over the long-term across many types of investments. Let’s look at the data over the last 20 years, from 2001 to December 2020. What does the data tell us?
- 88% of small and mid-cap stock funds underperformed their benchmark index.
- 96% of large-cap core funds underperformed their benchmark index.
- 91% of international stock funds underperformed their benchmark index.
- 92% of emerging market stock funds underperformed their benchmark index.
This superiority of index funds does not apply to just stocks. It also applies to bonds.
- 91% mortgage-backed bond funds underperformed their benchmark index over a 15-year period.
- 98% of high yield bond funds underperformed their benchmark index over a 15-year period.
S&P publishes these comparison studies every year, and the results are pretty consistent. So why choose index funds? Because investing in index funds will likely give you better returns than trying to pick winning stocks or trying to pick winning mutual funds. I’ll let you in on a little secret. About a third of mutual funds (which hire a bunch of managers to pick “winning” stocks) have become so large, they end up mimicking an index fund, while charging 1% in fees. It is no surprise that they will underperform an index fund, whose fees are a small fraction of that.
This leads me to the 2nd reason you may want to choose index funds: Index funds have very low fees. In 2020, the average expense ratio or fees of actively managed stock mutual funds was 0.71%, compared to 0.06% for the average index stock mutual fund. You’re paying a tenth in fees, meaning you get to keep more of your money than going to Wall Street.
Why Fidelity index funds?
We will start by saying we are not affiliated with Fidelity, nor do we get compensation from them. We are sharing with you our independent analysis. There are two main reasons we recommend Fidelity Index investing over other brokerage companies.
First, Fidelity index fund expense ratios or fees are one of the lowest out there. It’s even lower than Vanguard index funds, which spearheaded the concept of index investing back in 1976. Let’s take a look at the list of Fidelity index funds, and do a side-by-side comparison with Vanguard index funds.
As you can see, all 24 of these Fidelity index funds have lower fees or expense ratios compared to Vanguard index funds. Fidelity has gone even further and one-upped everyone by introducing four Fidelity zero-fee index funds.
ZERO fees. That’s hard to beat.
The second reason we recommend Fidelity is that Fidelity index funds have no minimums to open an account. In contrast, most Vanguard index funds require $3,000. Now that you understand the advantage of investing in Fidelity index funds, the next question then is how to start.
How to create a portfolio of Fidelity index funds
When getting started, there are 3 things you may want to avoid:
- You might be tempted to just buy in equal amounts across these 24 Fidelity index funds, in the name of diversification. You don’t want to do that. If you do, you won’t have enough exposure to the good types of investments. And you’ll end up buying Fidelity index funds that are not that great based on current market conditions.
- You might also be tempted to look at the performance of each, and just choose the ones that have performed best in the past 5 or 10 years. That’s backward-looking. That’s like driving while looking at the rearview mirror. Investing should be forward-looking.
- Choose the lowest cost & index in that. You may want to avoid doing that as well because you will miss several types of index funds that are also worth investing in.
To create the optimal portfolio of Fidelity index funds, I’ll be honest. It’s really best if you work with an independent, credentialed financial advisor who 1) understands the current market conditions and knows which one of these Fidelity index funds is worth buying, and 2) who can create a custom Fidelity index fund portfolio based on your goals and risk tolerance. Everyone is different. You have your own goal, your friend has a different goal. If you’re 35-years-old and would like to retire at 55, your Fidelity index fund portfolio is going to be very different from your friend who’s investing to purchase a house in 3 years.
How to buy Fidelity index funds
Step 1: Once you’re logged in, click on Trade at the upper left of the screen.
Step 2: A pop-up window will appear. Select the account you’d like to make a trade-in.
- Transaction Type: Choose Mutual Funds.
- Symbol: Enter the 5 letter symbol of the Fidelity index fund you’d like to buy.
- Action: Choose Buy.
- Amount: Input the amount in $.
Click on Preview Order.
Step 4: Review the information. If accurate, click on Place Order.
You now have purchased your Fidelity index fund!
That’s it! You have begun investing with the click of a few buttons. And best of all, you are investing in a low-cost and diversified way just by choosing to invest in Fidelity Index Funds over picking individual stocks or high-fee mutual funds. There is more to investing than these first steps, so make sure to check out our website for additional blogs and videos!
Interested in speaking with a financial advisor? Schedule a free discovery call with one of our financial advisors today.
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help middle-class professionals achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.