Author Topic: Is an index fund truly buy and hold?  (Read 5833 times)

Aphalite

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Is an index fund truly buy and hold?
« on: June 04, 2015, 02:16:39 PM »
Going through a thought exercise on holding an index fund versus holding a collection of individual stocks (splicing an index fund, for example). Let's say for the purposes of this exercise that we use the same weighting methodology TODAY for the index and for the portfolio of individual stocks that we hold (that's allocated using the exact same weightings as the total market fund)

For VTI/VTSMX/VTSAX, the fund manager will buy stocks whenever money comes in (say an investor buys VTI today) and have to sell stocks when money goes out. For a buy and hold investor, assuming no sales in the accumulation stage, he or she is constantly buying stocks when money comes in, but won't be selling any stocks

Normally, when the going is good and the stock market is rising, you have net money going into the index funds, as such, the fund manager will buy at market price. As long as equities are going up, you have an effect of "buying low" (ignoring the "adjusted float" concept that has been introduced to prevent front running). When equities are going down, neither the fund manager nor the individual stock investor has to sell low, as long as money isn't being pulled OUT of the fund.

My question is, is there anyway to look at historical total share count (instead of total net assets, to control for a falling equity market price) to see if money is pulled out of VTI/VTSMX/VTSAX when there is a depression (or when there is high volatility - admittedly this probably occurs less and does not have as much of an effect)? If share count does not decrease (by TOO much at least), then an index approach is truly buying and holding, but if the share count is decreasing, then that means you're in effect selling low in a depression on your existing shares as others are doing that for you. Net turnover is 3% today and was only 5% in 2009, does that encompass the effects of withdrawls on the fund? (As a sidenote, it really does seem that the total market fund attracts long term investors with turnover at 5% in 2009 versus the SP500 fund which had turnover at 12% in 2009, could be because the 500 fund is offered more often than the total market fund in 401k plans)

Looking at historical turnover, VTSMX has (from morningstar performance tracker):
History (05/31/2015)   Turnover Ratio
2005   12
2006   4
2007   4
2008   5
2009   5
2010   5
2011   5
2012   3
2013   4
2014   3

while SP500 VFINX has:
History (05/31/2015)   Turnover Ratio
2005   7
2006   5
2007   5
2008   6
2009   12
2010   5
2011   4
2012   3
2013   3
2014   3

Thoughts?

Edit: My main point is that it seems with a mutual fund of any kind, what other investors within the fund does impacts your money, whereas an individual stock purchaser would not be affected by this. Of course, you would have to have some way to keep your purchase fees at only 0.05% of your portfolio for this to be a fair comparison ($500 in trading costs each year for a $1m portfolio, or 100 trades at $5 per trade)
« Last Edit: June 04, 2015, 02:19:05 PM by Aphalite »

forummm

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Re: Is an index fund truly buy and hold?
« Reply #1 on: June 04, 2015, 02:25:06 PM »
I'm not sure I understand your question. For an individual investor, you can buy and hold an index fund. Other people may be selling around you, but you have the benefits of not losing out by trying to time the market, not having capital gains taxes eat your invested capital, etc. Other people buying and selling (and changes to the index as one company is added or removed) does cause some turnover in the fund, and that does slightly increase the cost in ER of the fund. And for some funds (but not VTSAX or VFIAX) that can cause capital gains distributions. But it doesn't affect the performance of the shares you hold because the stocks that you own are sitting right there the whole time. When you buy you are paying that day's closing price of the underlying stocks, and when you sell you are receiving that day's closing price of the underlying stocks.

matchewed

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Re: Is an index fund truly buy and hold?
« Reply #2 on: June 04, 2015, 02:29:42 PM »
The measure of buy and hold isn't upon what happens within the asset you've purchased but in the actions you take on the asset you've purchased.

So if you buy and hold the index fund then you have bought and held. But if you buy and sell the index fund when it has risen (or fallen) some arbitrary number then you have bought and sold.

Aphalite

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Re: Is an index fund truly buy and hold?
« Reply #3 on: June 04, 2015, 02:36:57 PM »
I'm not sure I understand your question. For an individual investor, you can buy and hold an index fund. Other people may be selling around you, but you have the benefits of not losing out by trying to time the market, not having capital gains taxes eat your invested capital, etc. Other people buying and selling (and changes to the index as one company is added or removed) does cause some turnover in the fund, and that does slightly increase the cost in ER of the fund. And for some funds (but not VTSAX or VFIAX) that can cause capital gains distributions. But it doesn't affect the performance of the shares you hold because the stocks that you own are sitting right there the whole time. When you buy you are paying that day's closing price of the underlying stocks, and when you sell you are receiving that day's closing price of the underlying stocks.

So the gist of my question is this. Let's say that VTI is $50 when you give the fund manager $500. That gives you 10 shares which encompasses all of the market at current weighting. But now that manager has to go BUY the shares of the company for you, because now he has $500 in cash that he must allocate. That means you essentially bought at $500. Fast forward a year, and the market TANKS to 50% of its value. No one has sold any shares yet so far, but a different investor than you finally has had it and decides to take his money out. He decides to take $250 out of the fund, the same $500 that you had. This means the fund manager must sell the $500 worth of stocks you had purchased for $250 because an investor OTHER THAN YOU paniced and withdrew his money. The market recovers, but now the fund is down $250. If not a lot of invstors in the fund do this, the $250 is a rounding error, but if a vast majority of investors do this, you get hit by their mistakes. It's a question of money going in and out of the fund, since an index must allocate its capital in accordance with the prospectus (now who knows, maybe VTI has a cash provision for this exact reason, but if it's not enough to cover redemptions during times of mass cash outflow, the fund manager must sell assets at a low price)

matchewed

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Re: Is an index fund truly buy and hold?
« Reply #4 on: June 04, 2015, 02:54:27 PM »
I'm not sure I understand your question. For an individual investor, you can buy and hold an index fund. Other people may be selling around you, but you have the benefits of not losing out by trying to time the market, not having capital gains taxes eat your invested capital, etc. Other people buying and selling (and changes to the index as one company is added or removed) does cause some turnover in the fund, and that does slightly increase the cost in ER of the fund. And for some funds (but not VTSAX or VFIAX) that can cause capital gains distributions. But it doesn't affect the performance of the shares you hold because the stocks that you own are sitting right there the whole time. When you buy you are paying that day's closing price of the underlying stocks, and when you sell you are receiving that day's closing price of the underlying stocks.

So the gist of my question is this. Let's say that VTI is $50 when you give the fund manager $500. That gives you 10 shares which encompasses all of the market at current weighting. But now that manager has to go BUY the shares of the company for you, because now he has $500 in cash that he must allocate. That means you essentially bought at $500. Fast forward a year, and the market TANKS to 50% of its value. No one has sold any shares yet so far, but a different investor than you finally has had it and decides to take his money out. He decides to take $250 out of the fund, the same $500 that you had. This means the fund manager must sell the $500 worth of stocks you had purchased for $250 because an investor OTHER THAN YOU paniced and withdrew his money. The market recovers, but now the fund is down $250. If not a lot of invstors in the fund do this, the $250 is a rounding error, but if a vast majority of investors do this, you get hit by their mistakes. It's a question of money going in and out of the fund, since an index must allocate its capital in accordance with the prospectus (now who knows, maybe VTI has a cash provision for this exact reason, but if it's not enough to cover redemptions during times of mass cash outflow, the fund manager must sell assets at a low price)

This is true for any traded asset. If you buy a single something @ $100, and then it is sold later at $50 the thing you once bought for $100 is worth $50. The idea is that this is only temporary, that the economic value of the market increases and therefor the price will eventually increase.

Also as long as you have the X number of shares the price of the share at any particular time doesn't matter except for when you go to sell or buy.

Aphalite

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Re: Is an index fund truly buy and hold?
« Reply #5 on: June 04, 2015, 03:03:05 PM »
@Matchewed

In this case, you as the investor is not doing anything. You're sitting pretty on your shares regardless of what other investors do. But I can't help but think the actions of other investors in the index funds do matter. The fund manager is powerless when it comes to inflows and outflows of capital.

Suppose the following scenario - I would think rare to occur but could happen (which is why I'm asking if anyone has a historical share count figure): Apple, which is the largest component of the index, is at $100 a share. If mass redemptions occur at the bottom of the market (let's assume a drop of 50%) as other investors in the fund pull out, the fund manager, with no cash on hand, has to sell shares to meet the redemptions, this means he sells apple at $50 a share. Now suppose that the market is recovering a little bit, and Apple is going back up at the behest of purchases by institutional investors/insiders/Warren Buffet, but personal investors who buy VTI are still scared, and they don't start buying VTI again until Apple has gone back up to $75. The net effect of the transaction means that the weighted average value of the fund has suffered, because the fund had to sell low and buy high, and this affects you, because while you are entitled to your share of Apple stock, the fund had to destroy value through no fault of its own.

Is there broken logic in my train of thought? Could very well be, but it seems the timing of cash inflows and outflows has an effect on the index fund as a whole, which is then passed to you, even though you didn't sell any shares during the collapse

index

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Re: Is an index fund truly buy and hold?
« Reply #6 on: June 04, 2015, 03:05:29 PM »
I'm not sure I understand your question. For an individual investor, you can buy and hold an index fund. Other people may be selling around you, but you have the benefits of not losing out by trying to time the market, not having capital gains taxes eat your invested capital, etc. Other people buying and selling (and changes to the index as one company is added or removed) does cause some turnover in the fund, and that does slightly increase the cost in ER of the fund. And for some funds (but not VTSAX or VFIAX) that can cause capital gains distributions. But it doesn't affect the performance of the shares you hold because the stocks that you own are sitting right there the whole time. When you buy you are paying that day's closing price of the underlying stocks, and when you sell you are receiving that day's closing price of the underlying stocks.

So the gist of my question is this. Let's say that VTI is $50 when you give the fund manager $500. That gives you 10 shares which encompasses all of the market at current weighting. But now that manager has to go BUY the shares of the company for you, because now he has $500 in cash that he must allocate. That means you essentially bought at $500. Fast forward a year, and the market TANKS to 50% of its value. No one has sold any shares yet so far, but a different investor than you finally has had it and decides to take his money out. He decides to take $250 out of the fund, the same $500 that you had. This means the fund manager must sell the $500 worth of stocks you had purchased for $250 because an investor OTHER THAN YOU paniced and withdrew his money. The market recovers, but now the fund is down $250. If not a lot of invstors in the fund do this, the $250 is a rounding error, but if a vast majority of investors do this, you get hit by their mistakes. It's a question of money going in and out of the fund, since an index must allocate its capital in accordance with the prospectus (now who knows, maybe VTI has a cash provision for this exact reason, but if it's not enough to cover redemptions during times of mass cash outflow, the fund manager must sell assets at a low price)

Shares are created and destroyed when there are transactions (purchases/redemptions) this is the concept of an open ended mutual fund.

Example:

Mutual fund XYZ has 10k in assets - 1000 shares at $10 per share.

Lets make it simple and say the mutual fund is invested 100% in Coca Cola KO (Say the price $30).

So the mutual fund owns $10k worth of KO at $30/share or 333.33 shares of KO. So each share of the 1000 shares of the mutual fund represents 0.33 shares of KO.

You come along and invest $500, the mutual fund manager goes and buys $500 of KO and gives you 50 shares of the XYZ. The mutual fund now has 1050 shares and holds 350 shares of KO. Each share of the mutual fund still represents  0.33 shares of KO.

The market tanks and KO is selling for $15. Another investor gets nervous and sells his 50 shares. The mutual fund manager goes and sells 16.6 shares of KO at $15 and gives the investor $250. Now the fund has 1000 shares and owns 333.33 shares of KO. Nothing changes for the investors who hold their money. Your $500 investment for 50 shares of of XYZ is still worth 16.6 shares of KO.

If every invest but you sells out. XYZ will only have 50 shares representing 16.6 shares of KO.

An index fund (or any open mutual fund) works in the same way. Instead of buying 100% KO though they are buying a 4% AAPL, 2% MSFT, 1% BRK/B, 1% GOOG etc... 

beltim

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Re: Is an index fund truly buy and hold?
« Reply #7 on: June 04, 2015, 03:06:48 PM »
Aphalite -

What you've described can be an issue in an actively managed fund, where a manager has to choose what assets to sell to meet redemptions.  But in an index fund, the manager has to sell in such a way as to maintain the portfolio percentages.  This means that your assets are completely unaffected by the behavior of other investors in the fund.

Aphalite

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Re: Is an index fund truly buy and hold?
« Reply #8 on: June 04, 2015, 03:10:00 PM »
An index fund (or any open mutual fund) works in the same way. Instead of buying 100% KO though they are buying a 4% AAPL, 2% MSFT, 1% BRK/B, 1% GOOG etc...

Okay, that makes sense, thanks

innerscorecard

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Re: Is an index fund truly buy and hold?
« Reply #9 on: June 04, 2015, 09:01:18 PM »
Index funds are only instruments. As it looks like you are realizing, despite the dogma often spouted around here, index funds can be traded as speculative instruments (in fact that is the case for many who think they are long-term investors in them), and individual stocks can be invested in for the long term.

hodedofome

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Re: Is an index fund truly buy and hold?
« Reply #10 on: June 05, 2015, 02:21:14 PM »
FWIW Vanguard charges $2 a trade for a $1 million account. Interactive Brokers charges $0.005 a share. You can do better than $5 a trade.


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beltim

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Re: Is an index fund truly buy and hold?
« Reply #11 on: June 05, 2015, 02:56:10 PM »
FWIW Vanguard charges $2 a trade for a $1 million account. Interactive Brokers charges $0.005 a share. You can do better than $5 a trade.


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But IB charges a $10/month minimum on commissions. Merrill Edge gives you 30 free trades per month - if you keep $25k IN CASH with them.  If you're only making 1 trade or so per month, isn't $5 per trade pretty good?

forummm

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Re: Is an index fund truly buy and hold?
« Reply #12 on: June 05, 2015, 07:07:43 PM »
FWIW Vanguard charges $2 a trade for a $1 million account. Interactive Brokers charges $0.005 a share. You can do better than $5 a trade.


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But IB charges a $10/month minimum on commissions. Merrill Edge gives you 30 free trades per month - if you keep $25k IN CASH with them.  If you're only making 1 trade or so per month, isn't $5 per trade pretty good?

Isn't IB's $10/mo waived if you have $100k invested?

innerscorecard

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Re: Is an index fund truly buy and hold?
« Reply #13 on: June 05, 2015, 08:20:36 PM »
FWIW Vanguard charges $2 a trade for a $1 million account. Interactive Brokers charges $0.005 a share. You can do better than $5 a trade.


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But IB charges a $10/month minimum on commissions. Merrill Edge gives you 30 free trades per month - if you keep $25k IN CASH with them.  If you're only making 1 trade or so per month, isn't $5 per trade pretty good?

You do not need $25,000 in cash if you qualify for their gold tier program, for which you only need $50,000 in total assets marked to market over a rolling three month average, which do not have to be cash.

sarajeanne

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Re: Is an index fund truly buy and hold?
« Reply #14 on: June 06, 2015, 11:11:58 AM »
Going back the original question, the answer is no, it is really not true buy and hold. There is still shuffling of the index based on changes to the index and changes to market cap (depending on the index). You have the discretion of those who decide who goes in the index, so it is really passive in the true sense of the word. Someone still has to pick and choose. The only real buy and hold is buying individual stocks and bonds and holding. It is the way to truly build wealth. I woundn't touch and index fund if you held a gun to my head. Only stocks and bonds and a few choice mutual funds for reits and international stocks.

beltim

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Re: Is an index fund truly buy and hold?
« Reply #15 on: June 06, 2015, 01:34:21 PM »
FWIW Vanguard charges $2 a trade for a $1 million account. Interactive Brokers charges $0.005 a share. You can do better than $5 a trade.


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But IB charges a $10/month minimum on commissions. Merrill Edge gives you 30 free trades per month - if you keep $25k IN CASH with them.  If you're only making 1 trade or so per month, isn't $5 per trade pretty good?

You do not need $25,000 in cash if you qualify for their gold tier program, for which you only need $50,000 in total assets marked to market over a rolling three month average, which do not have to be cash.

Ah, interesting.  My reading of that is that you have to have a BoA checking account in addition to that $50k in assets, right?

TheLazyMan

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Re: Is an index fund truly buy and hold?
« Reply #16 on: June 06, 2015, 02:11:11 PM »
But IB charges a $10/month minimum on commissions. Merrill Edge gives you 30 free trades per month - if you keep $25k IN CASH with them.  If you're only making 1 trade or so per month, isn't $5 per trade pretty good?

IB Minimum is only for accounts under $100k.