Financial Freedom SG

Read an interesting article about how index funds are evolving in the Wall Street Journal article “The New Supercharged Index Funds.”

An index fund is a form of unit trust that tracks an underlying index. For example, if OCBC or any of the local banks wake up their idea and decide to have an index fund that tracks the STI, the fund manager basically buys and sell stocks within the clearly defined basket of stocks in the STI.

This is unlike most unit trust fund manager who goes around seeking for stocks that can beat the market average. The index fund basically gives up on look for stocks that can beat the market and says, “Its okay to be average.” 

So the advantage of index funds over unit trust funds is that they have low annual fees. Since they don’t have fund managers trying to beat the market and incur transaction cost of doing that.

One key reason for choosing an index fund and have average returns is that a good fund that outperforms the market cannot be known to us. It is only known after time has passed. And choosing the best performing funds for the last year or even the past few years is no guarantee of continued good performance.

But the index funds have some disadvantages. One is that when the stocks in the index is changed, a lot of investor and fund manager will rush to sell the stock that is taken out and buy the stock that is put in the index.

So by the time the fund manager of the index funds rebalances the index fund, they will find that the stock they are trying to sell is already sold down and those they are trying to buy have already climbed significantly.

Another disadvantage is that when a smaller company in the index becomes successful and the market value increases, the index fund manager has to sell it and rebalance the index.

The article talks about placing partial weights on the various stocks which are grouped according to their size and set as proportions to the value of the total market, rather than fixed dollar amounts. This will enable the index fund manager to gradually add or eliminate a company from the index instead of all at once.

More exciting for me is that some of the more enlightened financial institutions in the list are eliminating brokerage commissions on selected ETFS. Imagine that.

Some financial institutions do get it. That keeping costs low for the customers is good for the customers and for themselves.

So when is Vanguard, Charles Schwab moving to Singapore?