Talk:Index fund

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[edit] Feedback loop

I am wondering, if index funds become more and more popular, would that cause like a feedback loop scenario?

Well, there is a well-known effect whereby whenever a stock is added to the S&P 500 index, it goes up a bit, because all of the S&P 500 index funds need to buy it.
Also, it's been suggested that last decade's bubble was in part the result of 401(K) investors who simply make an automatic dollar-cost-averaging contribution to an index fund every month, and are therefore in effect saying "I am willing to buy stocks no matter how much they cost." Dpbsmith 01:36, 5 Jul 2004 (UTC)
  • If you mean by feedback senario where passively manage fund get the free cake due to the Actively manage fund see Efficient market hypothesis, then yes. If everyone was to go passive then thier would be an incentive for active fund manager to do research and find underprice securities thus making a profit. Just know that if everyone went to passively manage index fund then the stock market would be a crap shoot, which will never happen in a capitalistic greedy economy. Paul.Paquette (talk) 19:18, 28 December 2005 (UTC)
No, when the market becomes less efficient, arbitrage operators, or fund managers can take advantage it, and fix the imbalance. --MegaHasher 06:48, 2 January 2006 (UTC)
But isn't there something a little paradoxical about this? If Bogle is right that "Investors as a group cannot outperform the market" then if one is a savvy investor will realise that on average she can not beat the market, and will invest in index funds rather than attempting to outperform the market, and therefore the market will not function as a market, so the investment will not be savvy, until it is, until it is not...--Timtak (talk) 02:03, 18 March 2008 (UTC)
Saying that investors as a group cannot outperform the market is different from saying that a single individual cannot outperform the market. Outperformance for one investor ('alpha' in financial lingo) must come at the expense of underperformance for another. Thus it is perfectly reasonable that investors may individually over or underperform while as a group ("on average") they do not.
Also, the arbitrageurs that people are referring to in the efficient market hypothesis are usually large fund managers who make their money from fees that derive either partly (in the case of hedge funds) or totally (mutual funds) from the amount of assets under management, not performance. Therefore funds will continue to have an incentive to actively manage funds regardless of whether the performance of their funds justifies the active management. -- Elch Yenn (talk) 18:36, 19 March 2008 (UTC)

[edit] Disadvantages

There should be some valid disadvantages. Perhaps we can say that an index fund will not outperform the target index. (while pointing out that it should not under-perform the target index)

Controversial disadvantages:

  • capital gains distribution - yes, but only individual stocks avoid this, and individual stocks are hard to diversify.
  • intra-day pricing - current index fund definitions include ETF, and ETFs do have intra-day pricing. Beside, intra-day pricing does not matter for long term investors. --MegaHasher 03:26, 4 January 2006 (UTC)

I think it is important to add back the advantage/ disadvantages that were seen on the other entries, with some of the recent edit these issues were simply deleted due to Point of View differences. Personally the benefits outweigh any disavangates that might be seen. Paul.Paquette (talk)

Paul: I don't understand your third point as worded. The index fund trade happens at 4pm daily, but I fail to see how it is related to lack of sector information. The sector pricing should be available from the sector ETFs should you want them. The main article should be in encyclopedia style, and it means no user names in main article, and written in clear neutral point of view. For "controversial" materials, a discussion from both sides should be included. Alternatively, controversial material may become clear with more explaination. --MegaHasher 01:19, 16 January 2006 (UTC)

[edit] New contents soon

I will have some new contents that will fix the POV issues, peacock terms, and a more encyclopedia style. --MegaHasher 21:56, 7 January 2006 (UTC)

  • Looks pretty good, but I'm sorry you cut out almost all the material on Burton Malkiel's role. Dpbsmith (talk) 22:52, 7 January 2006 (UTC)
I added Malkiel to the front of the history section. Bogle wrote about Samuelson, Ellis, and Ehrbar directly. Bogle certainly knew of Malkiel's work. I think this arrangement of paragraphs will work. --MegaHasher 03:01, 8 January 2006 (UTC)

[edit] Comments between MegaHasher & Paul.Paquette

Index funds are not very glamorous, and they lack the excitement and mystery of the active funds.

  • Point of view is slightly bias in favor so I throw this out all together. Excitement being Volatility, and Mystery being uncertainty. Is not the kind of advice I would want to give a passive investor.Paul.Paquette
OK. There are some grammar issues for later re-work. --MegaHasher 00:43, 28 January 2006 (UTC)
  • Index ETFs could be used by fund managers to reduce the amount of cash held in mutual funds. - How is this useful and where is the source for this? Paul.Paquette
Funds hold cash to meet redemptions, and this is a drag on performance. Recently some funds hold index ETFs or Vipers to sell intra-day to meet redemptions. Just look at some of Vanguard mutual funds' holdings; they are Vipers. [1] --MegaHasher 23:27, 27 January 2006 (UTC)
That is ingenious, why hold cash, let me just liquidate this ETF without making capital gains distribution and sell back the shares the next day, lol Paul.Paquette
  • ETFs can reduce capital gains distribution through "in-kind" creation and redemptions, but a change of index composition may still realize some capital gains (not in-kind). --MegaHasher 00:43, 28 January 2006 (UTC)

[edit] Capital gains distribution

Rather US-centric. What are the tax implications in other jurisdictions? Leibniz 14:09, 5 February 2006 (UTC)

Capital gains taxes are pretty common throughout the world, and it's something most people would have to worry about, even if the percentages vary. MrVoluntarist 17:46, 12 September 2006 (UTC)
That's not really true, as a look at the Capital Gains Tax page shows. In New Zealand for example index funds have a tax advantage because they are seen as passive not as active trading.NZ forever 03:11, 2 June 2007 (UTC)

[edit] Other

I changed the following sentences because of poor english and crazy claim about unamericanness:

When Bogle started the First Index Investment Trust on December 31, 1975, it was labeled Bogle's follies and regarded as un-American, because it sought to achieve the averages rather than insisting that Americans had to play to win. This first Index mutual fund offered to individual investors was later renamed the Vanguard 500 Index Fund, which tracks the Standard and Poor's 500 Index.

has been changed to

Bogle started the First Index Investment Trust on December 31, 1975. It was later renamed the Vanguard 500 Index Fund, which tracks the Standard and Poor's 500 Index.

Let me know if you disagree. Njerseyguy 18:28, 3 August 2007 (UTC)

I was curious enough about the statement since I recall having read something similar before that I did a bit of digging. Bogle's article "The First Index Mutual Fund: A History of Vanguard Index Trust and the Vanguard Index Strategy" supports the claim that competitors labeled index funds "un-American" and called the funds "Bogle's folly". The book All About Index Funds: The Easy Way to Get Started by Ferri makes the same claim and further attributes the comment that "I can't believe that the great mass of investors are going to be satisfied with receiving just average returns" to Fidelity Chairman Edward Johnson.
In light of the supporting references I think the information should be cleaned up grammatically and returned to the article. Elch Yenn 20:59, 3 August 2007 (UTC)

[edit] Not designed as portfolio templates

I am scratching my head on this addition. I am sure index funds are used as templates in portfolio constructions all the time. MegaHasher (talk) 03:05, 10 December 2007 (UTC)

I got that from a presentation from the CFA Institute. Basically they are not intended to be templates for portfolio construction eventhough they are used that way. They are merely intended to give a representation of a market. So for instance, the S&P500 is a representation of the large cap stocks in the US market but its not necessarily an optimum large cap portfolio. Pocopocopocopoco (talk) 03:09, 10 December 2007 (UTC)
I share MegaHasher's confusion about the "portfolio templates" addition, and feel that the section as worded is too vague to be meaningful. In particular, it sounds to me like the stated disadvantage is that the portfolio is "non-ideal" or "non-optimal", which is confusing because it's not clear what "ideal" or "optimal" is supposed to mean in this context.
I think rather than making a general claim of non-ideality, the description could be improved if you could specify exactly where you feel index funds fall short. For example, one criticism might be that the components of the S&P 500 are simply cap-weighted as opposed to being weighted to form a minimum variance portfolio, which could be a specific claim of suboptimality in the risk-to-return sense. -- Elch Yenn (talk) 04:46, 10 December 2007 (UTC)
I have reverted my contributions and I will review the meeting notes and try again but I think you are on the right track as to what I was getting at. Basically the optimal portfolio strives to maximize return but minimize risk (Beta. The index merely tries to reflect what's going on in a particular market. Pocopocopocopoco (talk) 05:39, 10 December 2007 (UTC)
It's not entirely true that the index funds ignore the mean-variance optimization idea. Assuming the "optimal portfolio" to which you're referring to is the Markowitz portfolio, the efficient market hypothesis (EMT) states that the stocks should be priced according to their weight in the optimal portfolio. If any given stock is not appropriately priced, then an arbitrage opportunity would exist and an active investor (a hedge fund or mutual fund manager, say) would profit by buying or selling the appropriate amount to bring the price to its "correct" value. Under the EMT assumption, you can piggyback off the work of others and obtain the optimal portfolio simply by purchasing the cap-weighted market portfolio, which is what most index funds do.
The gap between this theory and practice lie largely in the fact that market inefficiencies do exist. However, it's worth noting that index funds aren't chosen to be cap-weighted arbitrarily. A good general reference if you're interested in learning more about the history of index funds and portfolio theory in general is the first-year graduate finance text Investments by Bodie, Kane, and Marcus, which includes a pointer to the original paper published back in 1963 by William Sharpe that introduced the index model. -- Elch Yenn (talk) 12:50, 10 December 2007 (UTC)

[edit] Diversification

Diversification has it's own section but should it also be included as an advantage? Pocopocopocopoco (talk) 05:41, 10 December 2007 (UTC)

I read the diversification section, and I suspect the reason that whoever added it didn't put it under "Advantages/Disadvantages" is because not all index funds are equally diversified. The article makes the point that a sector index may be narrowly concentrated (i.e. poorly diversified) while a broad-based market index may be well diversified. Hence simply stating that a fund is an index fund does not in of itself guarantee good or poor diversification, and by putting "Diversification" in its own section, the current writeup avoids making a blanket statement that all index funds are well diversified. -- Elch Yenn (talk) 17:50, 10 December 2007 (UTC)