Vanguard's shot back in the index fund price war triggered by Fidelity last week hit home this morning in the Wall Street Journal (As Index Funds Slash Their Expenses, Think Twice Before You Take the Bait, September 8, 2004; Page D1). Jonathan Clements, the papers personal finance columnist, takes up Vanguard's theme and warns investors to be careful before they buy Fidelity's price reduced index funds lest they find themselves "checking into the roach motel."

For those not up to speed on the price fight, here is a quick overview. Fidelity kicked off the cuts last week when it sliced the fees on its lineup of index funds to levels that are the lowest in the industry. Its fund tracking the S&P 500, for example, now only charges 10 basis points. Yesterday, E*Trade also joined in by dropping the expenses on its equivalent fund to 9 bps.

Meanwhile, Vanguard chose to highlight the potentially temporary nature of its rivals' cuts rather than match the lower expenses. It pointed out in a press release that mentions no competitor by name (but does mimic the language used by Fidelity), that investors should be wary of buying funds that are waiving expenses rather than committing permanent price cuts.

While Vanguard's defensive play was picked up in Dan Weiner's newsletter last week, it is getting its most prominent play to date in today's Journal.

Clements not only takes up Vanguard's argument, he supports it with his own experience in 1990, when a similar price war broke out.

"The fund industry had been wowed by the success of the Vanguard 500 Index fund, the flagship index fund of the Malvern, Pa., fund company. Simply by mimicking the S&P 500, the fund had not only outpaced the vast majority of actively managed funds, but also it had attracted $2 billion from investors, then considered a huge sum," Clements writes.

"Hoping for similar success, both Fidelity and New York's Dreyfus, now a subsidiary of Mellon Financial, launched their own S&P 500 funds. Dreyfus initially waived all expenses, while Fidelity capped costs at 0.28%," he adds.

Meanwhile, Vanguard was charging 22 basis points for its flagship 500 Index fund. A good deal for investors, right? Not so, Clements points out. While Vanguard maintained its low expenses (and even reduced them), the sales at Dreyfus and Fidelity proved short-lived.

"The folks who poured millions into the Fidelity and Dreyfus funds didn't fare quite so well. The low costs were possible only because the funds were temporarily absorbing expenses. Indeed, by 1994, Dreyfus was charging 0.61% and Fidelity was levying 0.45%, according to Chicago's Morningstar Inc."

Clements concludes with the shot that could sink Fidelity's efforts to woo new shareholders with its price cuts if it takes hold with other reporters and becomes part of the conventional wisdom.

"Still, shareholders inclined to flee after the initial fee increases would have discovered that selling was far from painless. Which brings us to the roach motel. Remember how these devious devices work? You can check in, but you can't check out."  

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