[Bupp]

People buy index funds because they say that it is impossible to consistently outperform the market. While there is a lot of truth to this statement, it ignores an important reality. It is very inexpensive to purchase a portfolio of stocks that is representative of the index.

Let us assume that the tsx 60 will earn 10% a year for the next 40 years and we are able to buy $10,000 worth of it each year. At the end of the 40 years it we will have $4,868,518.

Most people assume the best way to capture that 10% A year is to buy index funds. Using the low cost option of XIU which charges a 0.17% management (and assuming no tracking error) our $10,000 annual investment will grow to only $4,641,697.

For the service of giving us a portfolio that replicates the tsx 60 we have payed over $225,000 during our investing career.

Furthermore, during year 41 we will be paying $7,890. Ouch!

So what is the alternative?

To keep costs to a minimum, an investor should invest in a no load index mutual fund until they have enough assets to purchase 100 shares of index etf. Once they have enough of the index etf to purchase the representative market (right now ~250k for tsx 60) they should sell their index funds and purchase the broader market.

Your thoughts?

Coles notes/tl;dr - if you invest 10k a year for 40 years at 10% indexing costs you $225,000 and $8,000+ per year during retirement. Why not just buy the stocks directly.

 

[Jon202]

I love the part about "will grow to only" 4.6 million. Eek! Cat food and Sally Ann for you!

 

[Bupp]

Haha, so true. I guess the point I'm making is that index funds are great for small portfolios. But once you are over a certain size invested in an asset class (I would argue 100k though could see 250k also being reasonable) they no longer make sense.

 

[Jungle]

So what is the alternative?

Go with HXT, 0.07%.

 

[Jungle]

Your example is extreme in that it's unlikely that the average person will invest 10k a year for 40 years straight, and walk around with 4.6 million in retirement fund.

Most people now are in their 20's with debt and can't even get a job after finishing school. So how they invest 10K a year starting in their 20's would be rather difficult.

You've calculated your XIU on a 40 year cost, when it doesn't makes sense to start out with ETF's until you have at least 25-50K. For some, it may take 10 years to to reach that level.

If you have 4.6 million, does an extra 200k really matter? Does that really add additional quality to your life when you can already live a luxury retirement?

 

[Jon202]

Do you really believe someone with a 7 figure portfolio is concerned about 1/10th of %? They're probably paying a high networth advisor much higher than what ETF MERs are.

 

[OptsyEagle]

I would focus on more important factors then the very small fee you are referring to. The dollar value of your costs (and I have not verified your math) is only large because of the large portfolio size you are using.

Most people don't just plunk down a fixed amount and leave it for 30 years. They add to it, withdraw from it and of course make changes to their plan. ETFs will make this a lot less costly and cumbersome then individual stocks.

 

[larry81]

you know its getting crazy when people are concerned paying >0.20% MER when the majority of investors are paying 2.5% MER...

 

[Belguy]

I am a simple man. Some might even say that I am a lazy man. Others may call me a cheapo.

Thus, I like to make one investment to track a given index and another to track a different index up to maybe a half dozen low fee, broad based ETF investments in total.

Then, I just like to hold them forever aside from rebalancing when required.

I consider the relatively small fee to be worth it in order to be properly diversified domestically and internationally.

Not to wish to sound flippant about it, but the rest of you can go about investing any way that you want and we will meet to compare results fifty years from now!!

Oh, and in the meantime, you'll find me on the 'Easy Chair' while you're doing all of your 'due diligence'.

 

[Greyhound86]

When I saw the title of this thread, I thought of one thing: Nortel

 

[larry81]

When I saw the title of this thread, I thought of one thing: Nortel

Same thing here...

 

[Jungle]

What would it cost to buy every share in VTI, VWO, VEA and XIC? (other than a big headace)

 

[Assetologist]

Cost of Doing Business

Each and every business has a annual cost to conduct the business. The mer you use in your example is actually quite low especially if that is your business's only real overhead.

Consider altering your viewpoint - investing is your business. Create a business plan, mission statement, financial statement, policy etc and then compare your 'costs' to other businesses.

PS
I buy individual stocks and target a buy cost of < 0.01% whenever possible but I am in the process of setting up a low-cost core ETF portfolio.

 

[Four Pillars]

It is very inexpensive to purchase a portfolio of stocks that is representative of the index.

I disagree. In terms of trading costs and the time costs (I value my time very highly), it is way more expensive to buy and maintain/rebalance a portfolio of ~60 stocks to replicated XIU.

What if you wanted to do XIC or VTI or VWO or VEA? Mmmmm?

 

[larry81]

What would it cost to buy every share in VTI, VWO, VEA and XIC? (other than a big headace)

even using a cheap 5$ brokers, it cost way to much... As an example, VTI has 3389 holdings...

 

[CanadianCapitalist]

Replicating an index on your own isn't very easy especially if you are adding money regularly to the portfolio. XIU's expense is 0.17%. Let's say you are paying $10 per trade. Just to replicate XIU's 60 stocks, you need to have $352,941 in Canadian stocks alone. More importantly, you have to live with some tracking error because you won't be able to perfectly mirror the index weights with this relatively small portfolio.

As other have noted unbundling an index is worthwhile in some cases: the REIT index, for instance. I don't see it being worthwhile in the case of XIU.

 

[Bupp]

Talking about XIU again, the biggest 10 holdings are almost 50% of the funds assets. Why not just buy those 10 stocks directly.

Conversely, the 10 smallest holdings are only 3.64% of assets. That 3.64% is not going to have a major impact on your returns.

Indexing has more problems then just the management fees...Index investor's get front run whenever there is a new addition to the index and for market-cap weighted indexes end up holding too much of past winners and not enough of past losers meaning that when markets mean-revert to the long term trend they get kicked in the nuts.

I get the whole idea that pro-managers are going to in aggregate underperform the stock market by the amount of their management fee. However, the same argument applies to index funds.

Why not just buy the stocks directly. Sure your holdings are no longer market cap weighted, but this is probably a good thing. Why does it make sense for an xiu investor to have an investment in royal bank that is 25 times greater than their investment in yellow media.

Sure you would need to rebalance periodically, but really your holdings would have to get really unbalanced to be as unbalanced as xiu is (you'd need a 5 bagger in a stock + a loss of 80% in a stock to approach the 25x royal/yellow media ratio.

 

[humble_pie]

but CC as argonaut has said, one shouldn't buy an entire index, one just wants to buy some of the better stuff. And be happy to leave the losers behind.

indexes themselves follow the better stuff rule. They regularly shed weak components & add strong newcomers. An individual investor can narrow down & refine this process imho.

 

[Jungle]

Well, you would not be properly diversified with just holding stocks from XIU. So how much would it cost, and how much time in your life would it take to manage stocks in XIU, VWO, VEA, VTI?

 

[Bupp]

For more re: why owning the index is bad check out page 5 of this article.

http://www.itg.com/news_events/papers/sandpindexchange.pdf

In particular, this section:

"symbols added to the S&P 500 tend to gain 8.5% between the announcement and the rebalancing date, while names deleted from the S&P 500 index tend to decline by 11.7%.2 Most of these price changes tend to reverse over the next year following the rebalancing. In the case of the deletes, the rebound is much more rapid, occurring within 1-2 weeks of the
rebalancing."

what this is saying is that when a stock is added to the index, the index is overpaying by 8.5%, when the stock is deleted, it gets sold for 11.7% less than it is worth. In the case of overpaying, the loss on average takes about a year. In the case of selling, the price regains it's 11.7% loss within 10 trading days.

This front running cost is a cost of indexing which is over and above the MER of the fund. It is a significant cost over longer periods of time.