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Comment by simo7 | Hacker News Reader

Thanks for the explanation, there are 2 things I don't quite understand though.

What is the advantage of building a replica of the S&P500 with individual stocks rather than having it done with an index fund? Isn't the second option much cheaper?

Secondly, isn't finding a subset of the S&P500 and trying to replicate it still an active strategy?

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Most investors are just like you and me. We have a basic portfolio which we needed managed cheaply.

But... huge amounts of assets are held by people/companies that may have odd holdings (ultra concentrated positions) or odd needs (liability matching). Those people/companies may need algorithms to help them move their portfolio to an optimal portfolio with minimum cost.

You can actually arb the SP500 components against the ETFs like SPY in a process that creates and redeems the ETF. This is how the ETF is kept in line.

I expect that there are tax advantages to holding individual stocks rather than an index fund.

Is finding a subset an active strategy? Depends. Do you do it every day, or do you figure out your subset and then buy and hold for fifteen years?

Is it passive when you rebalance against your target quarterly?

I think we can all agree that it's not passive when you are doing HFT, and anything which involves picking new stocks daily or weekly is active -- but having an algorithm do the rebalancing against your existing target daily and executing when a threshold is met? You're not making new picks, just readjusting against what you've already picked.

> I expect that there are tax advantages to holding individual stocks rather than an index fund.

None that I am aware of. Mutual funds can force capital gains realization, but ETFs do not.[0]

IMO there's no reason to roll your own index fund when you can just buy an ETF with a very low expense rate. If you have enough money that rolling your own (costs a fair amount to manage) is cheaper than the public fee, you might be eligible for a special shareclass rate anyway.

[0]: http://www.investopedia.com/articles/investing/090215/compar...

Here's one: as a US citizen living in Canada, I'm unable to invest in ETFs in Canada (e.g. Vanguard Canada's S&P500) without suffering punitive taxes and onerous reporting to the IRS. If it's an active investment, then it's fine, it's taxed as normal.

Unless you're playing with a million dollar, the fees for rebalancing are more expensive than any returns you might make. Especially if you have to trade hundreds of funds separately.

Don't rebalance quarterly either. Index funds are long term, meaning years.

Rebalancing ETFs is free or included in the price of a roboadvisor.

One tax advantage to approximating an index with individual stock positions is "tax loss harvesting": sell one stock at a loss and buy an equivalent. e.g., sell Coke and buy Pepsi. An advisor told me that you can add ~1% to your after tax returns. You need sufficiently large positions such that rebalancing transaction fees are negligible.

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