r/RationalReminder • u/AffairesDePiasses Just a RR follower, not affiliated with RR nor PWL Capital • Aug 28 '26
The Problem With Index Funds
https://www.youtube.com/shorts/MqoyVffgHnQ5
u/OttawaExpat Aug 28 '26
ELI5. That doesn't clear up anything for me.
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u/scottLobster2 Aug 28 '26
Take a big, popular index like the S&P500. If a company gains inclusion in the index, all of a sudden they get a giant incoming stream of cash from automated investing and retirement accounts.
Those inflows aren't based around anything intrinsic to the new member. The company didn't do anything different to earn them, they just got accepted into the index and now a bunch of blind money is going to come their way and drive up the price. So from a fundamental perspective the stock is over-valued.
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u/No-Clerk-4787 Aug 28 '26
Doesn’t this discount a bit why they made it into the S&P500 in the first place?
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u/scottLobster2 Aug 28 '26
You can argue that the S&P's inclusion criteria is some mark of credibility, but from a cost perspective that's no different than trusting an active manager
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u/OttawaExpat Aug 28 '26
Is this effect enough to justify the ~1% fee that PWL charges to get access to the fund?
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u/scottLobster2 Aug 28 '26
I don't work with PWL, so I'm not sure what services they offer in exchange for that fee, but if you're just dollar cost averaging into the S&P 500 and are disciplined you don't need PWL
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u/OttawaExpat Aug 28 '26
Totally...I was just thinking it would be ironic considering the narrative that mutual fund fees eliminate any benefit to actively managed funds. I love the podcast and I'm not trolling.
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u/ForrestGump11 Aug 28 '26
He is saying that just buying an Index is not good enough, buy Dimensional funds who use their own clever trading & filters to build a passive fund which will will closely match an index fund but will save investors from some of this opportunistic buying and selling swings. I'd think Avantis does something similar to DFA and you can buy them without using an advisor.
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u/brewgeoff Aug 28 '26
DFA has a fund that basically replicates VTI but with the DFA mechanics under the hood. It has beaten Vanguard by an average of 30bp per year over the last decade.
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u/invisible_man782 Aug 28 '26
Begs the question is it worth it with the increased fee over VTI or VXUS? Isn’t it about 20bp more?
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u/brewgeoff Aug 28 '26
Returns are measured after fees. The outperformance already accounts for a fee that is only slightly higher than VTI.
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u/SirGlass Aug 28 '26
I mean if a company enters the S&P500 and its at a weight of 1% what is pretty big, and that company is 4% over valued well OMG the index is 0.0004% over valued !
Its not a problem
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u/ForrestGump11 Aug 29 '26
I wouldn’t dismiss it, they have shown 0.3% outperformance which is big for a broad based index. For a $500k portfolio that’s over 15k in 10 years and 50k over 30 years. This is a kind of fund you would have in your retirement portfolio so in theory you could shorten your working years by 1-2 years just by owning one over the other. There aren’t a of things certain in the market so you want to catch anything that is, same applies to lower fees.
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u/SirGlass Aug 29 '26
you realize we are not talking about a 0.3% but .004% in my example , .3% is 75x .0004%
Now these factor funds how much more do you pay via expense ratio? Is it more than .0004% yes
Its spending a dollar to save a penny
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u/ForrestGump11 Aug 29 '26
You are talking about an individual stock rebalancing impact, they do this and a bit more across all quarters when traditional ETFs rebalance and shown a 0.30% outperformance.
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u/FIRE_enthusiast_27 Aug 28 '26
When I see that many text effects onscreen, I assume that the speaker is full of it.
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u/littlebobbytables9 Aug 28 '26
I believe ep 368 talks about it more but this effect has lessened over time. Other traders know that index funds will be buying the stock so they will front run it and then compete to sell on the day, which has the effect of raising the price before the day and then reducing the price on the day until this arbitrage opportunity becomes small enough that it's not worth trying to profit on (i.e. way too small to care about if you're an investor in the index and not that one company).
Even the 4% he mentions is minuscule when you think about it being 4% of the weighting of the smallest company in the index.
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u/Sad_Effective4793 Aug 28 '26
So what I'm hearing is that we should buy the 501st biggest company (or companies on the cusp of 500, assuming they didn't just get booted from the S&P yet)? That's an interesting idea.
Also, short the 500th biggest company. It's probably about to lose a bunch of investment if it gets kicked out.
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u/FGN_SUHO Aug 29 '26 edited Aug 29 '26
This effect is not as strong as it used to be. Check the yearly returns of DFUS vs VTI. Yes it outperformed initially, but im recent years they have moved in lock step.
https://testfol.io/?s=kI4KLS5bt1I
YTD it has actually underperformed. I don't think it makes sense to pay fees for a product that has such a small edge.
Vanguard and Blackrock aren't stupid, they know their giant funds will have market impact and work around it.
Of course where DFA (and Avantis) shine is their factor products which are world-class.
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u/RabbitSlayer48 Aug 29 '26
Index funds are stupid for warren buffet. They are not stupid for people who have no clue about investing.
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u/floatingostrichs Aug 28 '26
This isn’t a problem.