By Rob Schulz
Over the past 45 years, indexing has had a significant positive impact on the cost and quality of investment products. If you don’t know what indexing is, it’s when you own an investment product, generally a mutual fund or exchange-traded fund (ETF), that mirrors an index. It can be any index, but by far the most popular one is the S&P 500 that tracks US Large Cap stocks.
Indexes were initially created to provide tracking data and insight into market trends, but in 1975 John Bogle started what is now known as the Vanguard 500 Index mutual fund to blindly replicate the performance of the S&P 500. Over the preceding years, index funds revealed glaring problems with the investment products Wall Street was selling to the public, the most problematic being their high cost.
In order to compete, providers have had to bring their costs in line. This reduction in the cost of investment products has benefited most investors. Secondarily, many of today’s mutual funds and ETFs not only are cheaper; they are also better. Mutual fund and ETF providers have to go to great lengths to prove their worth to investors that now hold them to a higher standard of market performance.
But as previously mentioned, indexes were not designed to be investment vehicles. The primary criteria for a company to be included in the S&P 500 is that it be one of the 500 largest publicly-traded companies in the United States. Of course, this continually changes so companies are swapped out from time to time. On Dec. 21, we have a big change occurring as Tesla will be included in the S&P 500 for the first time. It is expected that Tesla will take over the 6th largest spot, somewhere between Facebook and Berkshire Hathaway. Since the announcement of their inclusion, Tesla is up over 40 percent in value, at least partially due to the well-known fact that tens of billions of dollars of Tesla stock will have to be purchased by index investments on Dec. 21.
This is a good example of an index not only tracking performance but also affecting stock prices. One could argue that the telegraphed intentions of the S&P 500 is creating a bad purchase price for index products. It’s kind of like when the Super Bowl comes to town and all of the hotels increase their prices to take advantage of the demand. It looks as if millions of index investors are going to pay top dollar for their Tesla shares come Dec. 21.
It would be nice if investing was as easy as just buying an index and forgetting about it, but unfortunately, it’s more complicated than that. The good news is that indexing has helped reduce a lot of the excess costs that used to be unavoidable. You can now buy a well-managed low-cost mutual fund or ETF that will make smarter trades based upon better criteria than index funds.
Rob Schulz is a local Certified Financial Planner and author of “Thoughts on Things Financial: Your Guide to a Chaotic Money World.” He can be reached at firstname.lastname@example.org. Buy his book by clicking here: https://www.schulzwealth.com/book/
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