The cost of indexing – and an approach how to reduce those costs

barometer_goethe_03There is a cost to indexing that most investors are unaware of. It is called “reconstitution.” What is reconstitution and how may the costs involved be solved?

What is an index? An index tracks changes in the markets – think of it kind of like a weather barometer.

The first article below discusses how the reconstitution effect increases the costs of adhering strictly to the holdings of an index. Each year, the index committee typically adds and removes, companies. These changes affect prices and timing.

The second article below discusses an alternative approach to experiencing the costs of index reconstitution, called “Asset Classes,” which allow the fund manager broader leeway as to when to buy or sell, along with a broader range of holdings. This discussion begins in the section called “Decision Two: Indexing or Asset Class Investing?”

The Asset Class approach, also referred to by others as “Factor Investing,” is based on what has become to be called “Evidence Based Investing” due to roots discussed in the linked “Factor Investing” article, that come from academic (peer reviewed and repeatable results) foundation that continues to this day.

Note: Your RSS feed or email may not show the embedded part of this blog … please go to the blog  to be able to read the complete post.

In the interest of disclosure: I do use DFA sub-managed SA Funds with most clients (not a fund requirement, but a business standardization decision I’ve made).

Analogies that explain the difference between investing and planning (Yes, they are different)! :

This blog is not a solicitation; simply an explanation of the basic philosophy and approach.

Photo: File:Barometer Goethe 03.jpg on Wikimedia Commons

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