If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

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Topic Author
index2max
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If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by index2max » Thu Oct 10, 2019 12:50 pm

I spoke with one of the phone reps at Charles Schwab to inquire more about their zero commission announcement for buying and selling US stocks and ETFs.

He made a point of distinguishing between commissions and fees. He said Charles Schwab is dropping their commissions, but there are fees charged by third parties upon the sale of stock such as exchange fees (NYESE, NASDAQ etc.) and those charged by the SEC. I believe he said there are no fees charged when you buy shares in a company.

I asked him whether there would be any sort of commission or fees charged if I wanted to build my own total US stock market index fund and buy shares in the 3500 companies listed in vanguard’s own fund, for example.

He did not know for sure, but he said it never hurts to read the small print. He also reminded me that it is not possible to purchase fractional shares of a company. You can only acquire fractional shares if you receive a dividend.

Is it now possible to build your own index fund by buying individual shares of stock commission-free with brokerage firms like Charles Schwab?

I would be very interested in doing this because it would allow me to retain voting rights, whereas when I buy into a mutual fund or ETF, the investment company (e.g. Vanguard Group) keeps the voting rights.
Last edited by index2max on Thu Oct 10, 2019 1:03 pm, edited 1 time in total.

Helo80
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by Helo80 » Thu Oct 10, 2019 12:56 pm

index2max wrote:
Thu Oct 10, 2019 12:50 pm
Is it now possible to build your own index fund by buying individual shares of stock commission-free with brokerage firms like Charles Schwab?

I would be very interested in doing this because it would allow me to retain voting rights, whereas when I buy into a mutual fund or ETF, the investment company (e.g. Vanguard Group) keeps the voting rights.

In short, yes, it would be theoretically possible to build your own index fund. However, having to re-balance 3500+ funds on a daily basis by yourself.... good luck with that.

Does Schwab have an API that personal investors can use to trade funds???? (I have no idea)

I'm curious though how much you plan on buying such that your voting rights would make any statistical difference in a vote's outcome... and how you plan on following the good/bad of the various issues at hand for 3500 publicly traded companies.

alex_686
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by alex_686 » Thu Oct 10, 2019 12:59 pm

index2max wrote:
Thu Oct 10, 2019 12:50 pm
Is it now possible to build your own index fund by buying individual shares of stock commission-free with brokerage firms like Charles Schwab?
It is in the realm of possibilities. It world take a fair amount of work to do. You would have to trade almost every day to closely hew to the index. Remember, each dividend has to be reinvested in 500 different stocks. Every time a company announces a new share issue or buy back you would need to rebalance. How much tracking error are you willing to accept. There are robo-adviser who will do it for a few basis points.

aristotelian
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by aristotelian » Thu Oct 10, 2019 1:02 pm

Check out M1 Finance. You do not even have to buy full shares, just create your pie and buy as you would an index fund. Only problem is limit of 100 stocks per account.

jumbopapa
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by jumbopapa » Thu Oct 10, 2019 1:05 pm

Would you have to buy full shares to do this? I assume so. What would be the minimum to get this started? You'd have to find the highest share price/s&p ratio and continually balance around that until you represented the full index? I would guess that means you start with BRK.B.

Edit: Not BRK.B - I confused it with BRK.A which isn't in the S&P per this site: http://siblisresearch.com/data/weights- ... companies/
Last edited by jumbopapa on Thu Oct 10, 2019 1:16 pm, edited 1 time in total.

barnaclebob
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by barnaclebob » Thu Oct 10, 2019 1:11 pm

jumbopapa wrote:
Thu Oct 10, 2019 1:05 pm
Would you have to buy full shares to do this? I assume so. What would be the minimum to get this started? You'd have to find the highest share price/s&p ratio and continually balance around that until you represented the full index? I would guess that means you start with BRK.B.
My guess is that it would take well into 8 figures to be able to get everything balanced correctly.

Also do index funds actually hold all of the stocks in an index? For some reason I thought they could still track the index without actually holding all of the stocks in the actual index using some fancy math.

Topic Author
index2max
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by index2max » Thu Oct 10, 2019 1:16 pm

This would make for one hell of a free software project if somebody could build an automated script to do all the rebalancing and pull the real time information from the index one’s following.

The Vanguard total US stock market fund pays dividend distributions four times per year. Each publicly traded company in the US operates their own fiscal year calendars, starting on Jan 1st or March 1st etc., right?

I guess I would need to learn more about the mechanics of how index funds work. Do index funds rebalance every day or do they only rebalance a few times per year? Are there any books or documentation out there describing the details of how index funds operate?

TropikThunder
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by TropikThunder » Thu Oct 10, 2019 1:22 pm

alex_686 wrote:
Thu Oct 10, 2019 12:59 pm
You would have to trade almost every day to closely hew to the index.
We always say the big benefit of an index fund is that it doesn’t have to trade to rebalance, everything just moves up and down in the market based on market cap. Why would it be any different for an individual? An index fund only needs to trade if inflows and outflows don’t balance and/or if the makeup of the index changes (like a small cap moves up to mid cap or the S&P500 adds/drops a company).

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by lazyday » Thu Oct 10, 2019 1:26 pm

index2max wrote:
Thu Oct 10, 2019 12:50 pm
I would be very interested in doing this because it would allow me to retain voting rights,
If I felt that way, then for my US allocation I might buy the 35 largest companies in approximately equal $ portion. If it's in a tax advantaged account, I'd probably rebalance every two or three years.

That's similar to what BRLIX Bridgeway Blue Chip fund does, or used to do years ago when I still read the annual reports. You can read the fund literature to see their justification for what they do, and look at how similar performance has been to the entire US market or to the S&P 500.

If it were in a taxable account, I'd probably try to tax loss harvest instead of rebalance.

I wouldn't buy thousands of companies. If in a taxable account, it would create a tax accounting nightmare. In any account, it would mean lots of shareholder lawsuits to either participate in, or ignore and suffer dilution. There's probably other downsides, see https://www.bogleheads.org/wiki/Passive ... ual_stocks

TropikThunder
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by TropikThunder » Thu Oct 10, 2019 1:31 pm

jumbopapa wrote:
Thu Oct 10, 2019 1:05 pm
Would you have to buy full shares to do this? I assume so. What would be the minimum to get this started? You'd have to find the highest share price/s&p ratio and continually balance around that until you represented the full index?
Exactly. And that’s just for the S&P500, imagine how much more it would take for a TSM index. The biggest company in VTIAX right now is Microsoft with a market cap of $1.05 trillion. One of the smallest is Alliance Data Systems with a market cap of ~$6 billion. For each dollar of ADM you’d need ~$166 of MSFT. But ADM sells for ~$120/share so you’d need ~$20,000 of MSFT to balance out one share of ADM. The multiplier would be at least 1,000 times higher for the bottom companies in a TSM fund. Whatever compromises and or deviations you would make will cause tracking error.

alex_686
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by alex_686 » Thu Oct 10, 2019 1:36 pm

TropikThunder wrote:
Thu Oct 10, 2019 1:22 pm
alex_686 wrote:
Thu Oct 10, 2019 12:59 pm
You would have to trade almost every day to closely hew to the index.
We always say the big benefit of an index fund is that it doesn’t have to trade to rebalance, everything just moves up and down in the market based on market cap. Why would it be any different for an individual? An index fund only needs to trade if inflows and outflows don’t balance and/or if the makeup of the index changes (like a small cap moves up to mid cap or the S&P500 adds/drops a company).
Bogleheads often oversimplify things. This is one example. I have been a fund accountant and had to take apart a few indexes in my day. As I put in my post "Remember, each dividend has to be reinvested in 500 different stocks. Every time a company announces a new share issue or buy back you would need to rebalance." Adjustments are constantly being made to the index. Plus, mergers, spins offs, special dividends, and other corporate actions. It is fiddly stuff but it is a lot of fiddly stuff. One could probably get away with reinvesting dividends & rebalancing once a month with little tracking error. After than you are going to start getting some cash drag.

IIRC, S&P 500 assumed that you would only reinvest your dividends once per month until the late 90s because of the computational & operational overhead involved.

alex_686
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by alex_686 » Thu Oct 10, 2019 1:41 pm

TropikThunder wrote:
Thu Oct 10, 2019 1:31 pm
Exactly. And that’s just for the S&P500, imagine how much more it would take for a TSM index. ... Whatever compromises and or deviations you would make will cause tracking error.
Well, how much tracking error are you willing to have? You can get a 20% tracking error with 20 to 40 stocks. So if the S&P were to return 10% you would probably get somewhere between 12% to 8%? Better tax loss harvesting, tax efficiencies, and being able to vote your stock are a positive. A solid statistical package and you can get down to 5% with under 100 stocks.

Small cap is a different story.

flyingaway
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by flyingaway » Thu Oct 10, 2019 3:17 pm

If I were you, I would build a "smart" index fund by removing those obvious bad companies.
If you are successful, you could start your own hedge fund.

Topic Author
index2max
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by index2max » Thu Oct 10, 2019 3:59 pm

alex_686 wrote:
Thu Oct 10, 2019 1:36 pm
TropikThunder wrote:
Thu Oct 10, 2019 1:22 pm
alex_686 wrote:
Thu Oct 10, 2019 12:59 pm
You would have to trade almost every day to closely hew to the index.
We always say the big benefit of an index fund is that it doesn’t have to trade to rebalance, everything just moves up and down in the market based on market cap. Why would it be any different for an individual? An index fund only needs to trade if inflows and outflows don’t balance and/or if the makeup of the index changes (like a small cap moves up to mid cap or the S&P500 adds/drops a company).
Bogleheads often oversimplify things. This is one example. I have been a fund accountant and had to take apart a few indexes in my day. As I put in my post "Remember, each dividend has to be reinvested in 500 different stocks. Every time a company announces a new share issue or buy back you would need to rebalance." Adjustments are constantly being made to the index. Plus, mergers, spins offs, special dividends, and other corporate actions. It is fiddly stuff but it is a lot of fiddly stuff. One could probably get away with reinvesting dividends & rebalancing once a month with little tracking error. After than you are going to start getting some cash drag.

IIRC, S&P 500 assumed that you would only reinvest your dividends once per month until the late 90s because of the computational & operational overhead involved.
Thanks for commenting on this thread. I was hoping to get some insightful posts about the technical hurdles such a project would have to overcome.

When an S&P index fund provider pays Dow Jones to license the S&P 500 index, doesn’t that provide them real-time data on the weighting of each stock in the index?

If so, wouldn’t that outsource the time and effort required to track of the number of outstanding shares floating in the secondary market place, dividends etc.?

That’s why index fund providers pay Dow Jones to license the S&P 500 index in the first place right? Not to mention it is a well-known, trusted index.

DonIce
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by DonIce » Thu Oct 10, 2019 4:14 pm

You can get pretty good tracking with just 30 stocks, as illustrated by how strongly correlated the Dow is with the S&P500. You wouldn't need to hold all 500 stocks in the S&P500, and certainly not all 3500+ in TSM.

Pick 50-100 representative stocks.

If you did this at M1, you can auto-rebalance in one click at no cost, and they support fractional shares. You just need to specify what % of your portfolio each stock should be, and it would probably be good enough to update those percentages once per year.

alex_686
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by alex_686 » Thu Oct 10, 2019 4:20 pm

index2max wrote:
Thu Oct 10, 2019 3:59 pm
When an S&P index fund provider pays Dow Jones to license the S&P 500 index, doesn’t that provide them real-time data on the weighting of each stock in the index?
First, a nit. You pay Standard & Poor for the S&P 500 index. DJ offers other indexes, CRSP offers others.

Second - I am not sure what the thrust of your question is. S&P does provide a range of data - some free, some premium. The free end-of-day data is probably sufficient, but you would need to extract it, transform the raw data (the free stuff won't tell you what exactly has changed), then transform that data into actionable buy/sell orders. I doubt you have sufficient funds to buy and sell whole shares to get down to the precision that S&P tracks. The premium stuff is expensive. A Bloomberg terminal could probably spit out the buy / sell orders, but that costs big bucks.

That being said, how much does this matter? The cons are obvious. High and continuous effort, tracking error, and cash drag. The pros are less obvious. Generating tax alpha is obvious, but you need a very efficient system to justify squeezing out that extra little return.

WildcatTofu
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by WildcatTofu » Thu Oct 10, 2019 5:07 pm

DonIce wrote:
Thu Oct 10, 2019 4:14 pm
You can get pretty good tracking with just 30 stocks, as illustrated by how strongly correlated the Dow is with the S&P500. You wouldn't need to hold all 500 stocks in the S&P500, and certainly not all 3500+ in TSM.

Pick 50-100 representative stocks.

If you did this at M1, you can auto-rebalance in one click at no cost, and they support fractional shares. You just need to specify what % of your portfolio each stock should be, and it would probably be good enough to update those percentages once per year.
Isn't this the wealthfront's business model? Wealthfront purchases individual securities to replicate S&P 500 index for their clients.

Wealthfront has been running this business since 2008. Given their tracking record, I won't purchases individual securities to replicate S&P 500 index fund by myself. If a company with 100+ employees cannot do it well, I doubt (as a part-time job) I can do better than wealthfront does.

robertmcd
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by robertmcd » Thu Oct 10, 2019 5:09 pm

WildcatTofu wrote:
Thu Oct 10, 2019 5:07 pm
DonIce wrote:
Thu Oct 10, 2019 4:14 pm
You can get pretty good tracking with just 30 stocks, as illustrated by how strongly correlated the Dow is with the S&P500. You wouldn't need to hold all 500 stocks in the S&P500, and certainly not all 3500+ in TSM.

Pick 50-100 representative stocks.

If you did this at M1, you can auto-rebalance in one click at no cost, and they support fractional shares. You just need to specify what % of your portfolio each stock should be, and it would probably be good enough to update those percentages once per year.
Isn't this the wealthfront's business model? Wealthfront purchases individual securities to replicate S&P 500 index for their clients.

Wealthfront has been running this business since 2008. Given their tracking record, I won't purchases individual securities to replicate S&P 500 index fund by myself. If a company with 100+ employees cannot do it well, I doubt (as a part-time job) I can do better than wealthfront does.
Yeah it's known as direct indexing

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by MotoTrojan » Thu Oct 10, 2019 5:11 pm

Helo80 wrote:
Thu Oct 10, 2019 12:56 pm
index2max wrote:
Thu Oct 10, 2019 12:50 pm
Is it now possible to build your own index fund by buying individual shares of stock commission-free with brokerage firms like Charles Schwab?

I would be very interested in doing this because it would allow me to retain voting rights, whereas when I buy into a mutual fund or ETF, the investment company (e.g. Vanguard Group) keeps the voting rights.

In short, yes, it would be theoretically possible to build your own index fund. However, having to re-balance 3500+ funds on a daily basis by yourself.... good luck with that.

Does Schwab have an API that personal investors can use to trade funds???? (I have no idea)

I'm curious though how much you plan on buying such that your voting rights would make any statistical difference in a vote's outcome... and how you plan on following the good/bad of the various issues at hand for 3500 publicly traded companies.
While it would be absurd to actually try and hold all 3500+ funds, re-balancing wouldn't be a problem if you purchased them initially at market cap.

OP, check-out the S&P500 returns vs. Total US, pretty similar, eh? You definitely don't need 3500 stocks to get market exposure.

FWIW M1 Finance does allow fractional share ownership so that would be the place to do this if you were using a normal portfolio dollar amount.

Can't recall the broker but there is one that has a service for those with larger accounts (>?$500K maybe?) where they will make a synthetic index that aims to track the S&P500 but will tax-loss harvest losing companies and replace them with others in the same industry. Overall it will track the S&P500 somewhat well, while also generating losses for tax credit, even if the overall market never goes down.

retired@50
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by retired@50 » Thu Oct 10, 2019 5:18 pm

index2max wrote:
Thu Oct 10, 2019 12:50 pm

I would be very interested in doing this because it would allow me to retain voting rights, whereas when I buy into a mutual fund or ETF, the investment company (e.g. Vanguard Group) keeps the voting rights.
If I were you, I'd find something else to do with my time, instead of trying to intelligently research appropriate voting positions on 500 or perhaps 3500 public companies. Life is short. Buy an index fund and go do something else you enjoy. Regards,

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by GeraniumLover » Thu Oct 10, 2019 5:29 pm

DonIce wrote:
Thu Oct 10, 2019 4:14 pm
You can get pretty good tracking with just 30 stocks, as illustrated by how strongly correlated the Dow is with the S&P500. You wouldn't need to hold all 500 stocks in the S&P500, and certainly not all 3500+ in TSM.

Pick 50-100 representative stocks.
How are you going to pick the small- and micro- cap to replicate TSM?

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index2max
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by index2max » Thu Oct 10, 2019 5:49 pm

retired@50 wrote:
Thu Oct 10, 2019 5:18 pm
index2max wrote:
Thu Oct 10, 2019 12:50 pm

I would be very interested in doing this because it would allow me to retain voting rights, whereas when I buy into a mutual fund or ETF, the investment company (e.g. Vanguard Group) keeps the voting rights.
If I were you, I'd find something else to do with my time, instead of trying to intelligently research appropriate voting positions on 500 or perhaps 3500 public companies. Life is short. Buy an index fund and go do something else you enjoy. Regards,
Of course it's not realistic for me to be able to do research on ALL the companies in the TSM. Everyone would pitch in their own research and discuss online (e.g. "Here's why I suggest we all vote to change the board of Apple" etc.). Think of it like an open source programming project that you'd find online where people can contribute as much or as little as they please. I believe in proxy votes, if a shareholder doesn't place a vote, their shares vote yea by default.

Would you tell someone not to vote in local, county, state or federal elections because they might not know 100% about each candidate? Obviously people have to make decisions with just a gut feeling or only partial info

I didn't want to get too much into my motivations for wanting to building my own index fund in this thread so I can keep on topic. I'll make a different thread going further into my motivations for wanting to pursue this someday. Basically it's about preventing firms like Vanguard and Blackrock from having too much power. The U.S. government was built on a system of checks and balances. Why not give the people who are putting their live savings into the stock market a bigger say in how American companies are run?
robertmcd wrote:
Thu Oct 10, 2019 5:09 pm
WildcatTofu wrote:
Thu Oct 10, 2019 5:07 pm
DonIce wrote:
Thu Oct 10, 2019 4:14 pm
You can get pretty good tracking with just 30 stocks, as illustrated by how strongly correlated the Dow is with the S&P500. You wouldn't need to hold all 500 stocks in the S&P500, and certainly not all 3500+ in TSM.

Pick 50-100 representative stocks.

If you did this at M1, you can auto-rebalance in one click at no cost, and they support fractional shares. You just need to specify what % of your portfolio each stock should be, and it would probably be good enough to update those percentages once per year.
Isn't this the wealthfront's business model? Wealthfront purchases individual securities to replicate S&P 500 index for their clients.

Wealthfront has been running this business since 2008. Given their tracking record, I won't purchases individual securities to replicate S&P 500 index fund by myself. If a company with 100+ employees cannot do it well, I doubt (as a part-time job) I can do better than wealthfront does.
Yeah it's known as direct indexing
I figured I wasn't the first to think of this concept. Thanks for telling us it's called "Direct Indexing".

I'm curious to see what other firms charge for such a service. They'd probably expect me to walk in with a few hundred to make it worth their while as things stand right now before most of these brokerage firms drop their commissions to zero.
Last edited by index2max on Thu Oct 10, 2019 6:08 pm, edited 1 time in total.

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whodidntante
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by whodidntante » Thu Oct 10, 2019 6:05 pm

If you are extremely wealthy and invest solely in microcap companies, this may allow you to affect what happens there. Apple doesn't care what you think.

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index2max
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by index2max » Thu Oct 10, 2019 6:12 pm

whodidntante wrote:
Thu Oct 10, 2019 6:05 pm
If you are extremely wealthy and invest solely in microcap companies, this may allow you to affect what happens there. Apple doesn't care what you think.
I'm using Apple as an example because it is a well-known company. If enough individuals were voting, I believe it would make a big difference. With micro and small-cap companies, yeah an individual's vote will have a bigger difference since the institutional investment firms own fewer of those shares compared to large-cap S&P 500 companies.

As an aside, I don't care what Apple thinks either. I'm switching my devices to GNU/Linux :mrgreen:

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Random Musings
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by Random Musings » Thu Oct 10, 2019 6:42 pm

For people with a lot of spare time (and money) on their hands, replicating the Total Stock Market Index would certainly be a lot of fun. :oops:

Or, have Vanguard take care of it. Low ER, good tracking, and so on.

For a smaller basket of stocks, doable, but requires discipline. Plus, unless schooled properly, heirs might believe you were a stock traders and not just replicating an index. Could send the wrong signal.

RM
I figure the odds be fifty-fifty I just might have something to say. FZ

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by MarkVH0518 » Thu Oct 10, 2019 7:46 pm

Why would there ever be a need for rebalancing?
You purchase each stock in the S&P500 at the appropriate market cap and hold on forever.
The only purchase and sales are for stocks moving into and out of the index.

That's why indexing is cheap. There no churning.

Mark

alex_686
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by alex_686 » Thu Oct 10, 2019 7:58 pm

index2max wrote:
Thu Oct 10, 2019 5:49 pm
Of course it's not realistic for me to be able to do research on ALL the companies in the TSM. Everyone would pitch in their own research and discuss online (e.g. "Here's why I suggest we all vote to change the board of Apple" etc.). Think of it like an open source programming project that you'd find online where people can contribute as much or as little as they please. I believe in proxy votes, if a shareholder doesn't place a vote, their shares vote yea by default.

Would you tell someone not to vote in local, county, state or federal elections because they might not know 100% about each candidate? Obviously people have to make decisions with just a gut feeling or only partial info...

I'm curious to see what other firms charge for such a service. They'd probably expect me to walk in with a few hundred to make it worth their while as things stand right now before most of these brokerage firms drop their commissions to zero.
2 big points.

Zero commissions does not mean free trading. While direct costs (commissions) may drop to zero, implicit costs will not. Read up on the bid-ask spread and high frequency trading.

Next, I appreciate your utopian vision. There are massive structural, technical, and regulatory issues. There are so many I don't know where to start. So pick one and we can dig down.

rascott
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by rascott » Thu Oct 10, 2019 8:22 pm

I could make a list of probably 1000x things that would be a more efficient/ profitable use of one's time than this idea.

Strayshot
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by Strayshot » Thu Oct 10, 2019 8:55 pm

At current expense ratios in the .02% range for index funds, you would need millions of dollars to come close to making this remotely worth your time.

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index2max
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by index2max » Thu Oct 10, 2019 9:19 pm

alex_686 wrote:
Thu Oct 10, 2019 7:58 pm
index2max wrote:
Thu Oct 10, 2019 5:49 pm
Of course it's not realistic for me to be able to do research on ALL the companies in the TSM. Everyone would pitch in their own research and discuss online (e.g. "Here's why I suggest we all vote to change the board of Apple" etc.). Think of it like an open source programming project that you'd find online where people can contribute as much or as little as they please. I believe in proxy votes, if a shareholder doesn't place a vote, their shares vote yea by default.

Would you tell someone not to vote in local, county, state or federal elections because they might not know 100% about each candidate? Obviously people have to make decisions with just a gut feeling or only partial info...

I'm curious to see what other firms charge for such a service. They'd probably expect me to walk in with a few hundred to make it worth their while as things stand right now before most of these brokerage firms drop their commissions to zero.
2 big points.

Zero commissions does not mean free trading. While direct costs (commissions) may drop to zero, implicit costs will not. Read up on the bid-ask spread and high frequency trading.

Next, I appreciate your utopian vision. There are massive structural, technical, and regulatory issues. There are so many I don't know where to start. So pick one and we can dig down.
Thanks for mentioning about the implicit costs, I figure if I'm buying at the market rate, the brokerage firm can just as easily wait a few minutes for the spread to be more in their favor and pocket the difference.

The next best thing I can think of would be convincing Vanguard to allow fund owners the privilege of being able to vote on shareholder proposals, for the price of a higher expense ratio. It's possible they would be willing to offer this additional service on top of their index funds for a price.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by RandomWord » Thu Oct 10, 2019 10:26 pm

alex_686 wrote:
Thu Oct 10, 2019 1:36 pm
TropikThunder wrote:
Thu Oct 10, 2019 1:22 pm
alex_686 wrote:
Thu Oct 10, 2019 12:59 pm
You would have to trade almost every day to closely hew to the index.
We always say the big benefit of an index fund is that it doesn’t have to trade to rebalance, everything just moves up and down in the market based on market cap. Why would it be any different for an individual? An index fund only needs to trade if inflows and outflows don’t balance and/or if the makeup of the index changes (like a small cap moves up to mid cap or the S&P500 adds/drops a company).
Bogleheads often oversimplify things. This is one example. I have been a fund accountant and had to take apart a few indexes in my day. As I put in my post "Remember, each dividend has to be reinvested in 500 different stocks. Every time a company announces a new share issue or buy back you would need to rebalance." Adjustments are constantly being made to the index. Plus, mergers, spins offs, special dividends, and other corporate actions. It is fiddly stuff but it is a lot of fiddly stuff. One could probably get away with reinvesting dividends & rebalancing once a month with little tracking error. After than you are going to start getting some cash drag.

IIRC, S&P 500 assumed that you would only reinvest your dividends once per month until the late 90s because of the computational & operational overhead involved.
Suppose I didn't bother rebalancing at all. Let's say I just bought all 500 (or 3500, or whatever index you want) stocks at market cap, and then held onto them for 10 years. How far off from the index would they be at that point?

I know it's just 0.03% or whatever, but the expense ratio does still irk me a little. And I'm not sure it actually matters having a portfolio that's "almost" market cap rather than perfectly cap weighted.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by UpperNwGuy » Fri Oct 11, 2019 5:13 am

I don't understand why you consider voting rights to be so important.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by nisiprius » Fri Oct 11, 2019 6:50 am

Suppose that once you have gotten the knack of it you can place a stock trade in three minutes on a brokerage website. Suppose you've made your list of call-it-3,500, or 500, stock ticker symbols, and you have your spreadsheet set up to show you the number of shares you need to buy of each to equal the approximate total you want to buy. It would take you 3,500 x 3 = 10,500 minutes = 175 hours = four 40-hour weeks to buy them. For just the S&P 500, 25 hours, or three 8-hour days.

Personal direct indexing isn't going anywhere until there are user-friendly, automated trading tools to go along with the zero-commission fees. There would need to be some website combining a stock screener to help you assemble a list meeting some criteria, a way to enter the relative allocations, and so on.

With cap-weighting, there needn't be any transactions for rebalancing, but whenever you wanted to buy or sell you would need some way to place 3,500 trades (for the total market), or even 500 trades. If you contribute to retirement savings once a month, that's 42,000... or 6,000 for the S&P 500... trades a year.

There's still bid-asked spread even if there isn't a fee.

In a taxable account there are still tax considerations from purchases and sales and they might get hard to manage if you are doing 42,000 trades a year.

You'd better be sure you have enrolled for electronic statements if every month you are going to create 3,500 line items on your statement.

If you wanted to base what you are doing off a real index, there are interesting issues because index providers charge fees to use their index. So while it might be attractive to someone to say "I want the S&P 500 but without the FAANGs" or "I want Dow Jones Total Stock Market index except for Altria and Tilray," you probably couldn't get access to the index in a direct-indexing tool without paying a fee.

If the mechanism for automatically placing the trades isn't a built-in brokerage feature--if you have to use a third-party app or website to do it--the security considerations are daunting. And imagine a glitch, when push the button to place 500 sales, and 223 of them go through and then something stalls or crashes. And you need to find out which they were, and sell the 277 of them to get the money you needed. And then, of course overnight something comes back to life and finishes the other 277, and maybe you need to hold the cash for a month before buying them back, or create 277 wash sales or something.

And if brokerages are not making money--if they are actually incurring a small loss--on zero-fee transactions, then if third-party direct indexing apps arose, and suddenly thousands of customers were making 42,000 trades a year instead of the few hundred or so they expected, they would probably institute caps and limits... and fees above that limit. Unlimited free trades would turn out to be like "unlimited free data" on cell phone plans.
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by GoldenFinch » Fri Oct 11, 2019 7:25 am

Building your own index fund sounds like both a full time job and an experiment. I would think your risk of behavioral mistakes would skyrocket.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by robertmcd » Fri Oct 11, 2019 9:17 am

"Direct Indexing" really serves no purpose anymore IMO. Sure it allows stock level TLH but do you really need that? I can TLH between dozens of highly liquid ETF's with ER's of like .05 and below.

This forum can get too obsessed with single basis point ER differences when the most important factor is honestly going to be minimizing the amount in your checking account, and your brokerage sweep account at all times if you are that frugal.

Use highly liquid ETFs w/ low ER's or vanguard mutual funds w/ low ER's in taxable. Use any low cost mutual fund or a low cost liquid ETF in tax advantaged. Just don't pay any commissions. Don't obsess for days over whether or not to use fidelity zero vs. vanguard total stock market. IT DOESN'T MATTER! Life is about time management and opportunity cost, and there are much better things to learn/focus on to make more money/save money.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by David Jay » Fri Oct 11, 2019 9:47 am

You remind me of the story of the boy walking along the beach, throwing stranded starfish back into the surf. An old man is sitting there observing this and finally speaks up: “You can’t make a difference in ocean life”. The boy replies (as he tosses another starfish back into the ocean): “I can make a difference for this one”.

I feel Ike you are trying to change the ocean. Instead, pick one company and make a difference in their governance. Buy Total Stock with 90% of your retirement portfolio, then take the last million and purchase a nice stake in one micro-cap. Vote your conscience. Maybe even get an occasional meeting with the CEO or Chairman. This will not be symbolic, you may actually make a difference in the governance of the firm.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by index2max » Sun Oct 13, 2019 11:20 pm

David Jay wrote:
Fri Oct 11, 2019 9:47 am
You remind me of the story of the boy walking along the beach, throwing stranded starfish back into the surf. An old man is sitting there observing this and finally speaks up: “You can’t make a difference in ocean life”. The boy replies (as he tosses another starfish back into the ocean): “I can make a difference for this one”.

I feel Ike you are trying to change the ocean. Instead, pick one company and make a difference in their governance. Buy Total Stock with 90% of your retirement portfolio, then take the last million and purchase a nice stake in one micro-cap. Vote your conscience. Maybe even get an occasional meeting with the CEO or Chairman. This will not be symbolic, you may actually make a difference in the governance of the firm.
lol, yes I understand where you are coming from, but considering commissions seem to be going away for individual stock purchases, I was simply trying to figure out where it's now actually possible (and affordable!) for the little guy to do direct indexing on his own.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by BH+ » Sun Oct 13, 2019 11:52 pm

You could probably get similar results by buying the top 30 stocks of the S&P500 and holding them in market cap weight. Then take the dividends each year and add the 31st stock, and so on.

You could also equal weight those stocks or control your sector allocation, if you prefer to do so. This is what I would do if I were to dabble in direct stock investing.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by David Jay » Mon Oct 14, 2019 7:27 am

index2max wrote:
Sun Oct 13, 2019 11:20 pm
David Jay wrote:
Fri Oct 11, 2019 9:47 am
You remind me of the story of the boy walking along the beach, throwing stranded starfish back into the surf. An old man is sitting there observing this and finally speaks up: “You can’t make a difference in ocean life”. The boy replies (as he tosses another starfish back into the ocean): “I can make a difference for this one”.

I feel Ike you are trying to change the ocean. Instead, pick one company and make a difference in their governance. Buy Total Stock with 90% of your retirement portfolio, then take the last million and purchase a nice stake in one micro-cap. Vote your conscience. Maybe even get an occasional meeting with the CEO or Chairman. This will not be symbolic, you may actually make a difference in the governance of the firm.
lol, yes I understand where you are coming from, but considering commissions seem to be going away for individual stock purchases, I was simply trying to figure out where it's now actually possible (and affordable!) for the little guy to do direct indexing on his own.
It is not “affordable” if you assign any value to your time.

[edit] I’m glad you took my point and the spirit in which it was offered. Your idealism is admirable but you - index2max - are not going to change corporate governance by building your own index fund to maintain voting rights. And you will not be starting a significant trend because not one investor in 10,000 will put in the time and effort to follow your pattern. Instead, pick one project in your life where you can make a difference - whatever it may be - and put your time and effort into that one project.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by afan » Mon Oct 14, 2019 1:05 pm

No one runs an index fund manually. To create your own index fund you would need to automate all the trading. To reproduce what index funds do you would also need to use options and futures to stay fully invested while some of your money is temporarily in cash.

Running an index fund is not as simple as making an initial purchase and sitting on the same stocks year in and year out. If nothing else, you have to reinvest dividends. Not in the company that paid them but in the index. So 3,500 purchases many times a month. All in the correct proportions.

Companies go out of business, merge , get acquired or spin off other businesses. Every time this happens you need to react to remain matching the index.

Who will manage your stock loan portfolio? That generates enough money to offset all the costs for VTI. Ignore it and you trail the index funds.

Then if you are not voting your proxy on every company, what was the point of holding individual stocks?

At very large amounts of money you could hire a team to run your index fund for you. If the asset base were large enough then the economies of scale would get the price down to what Vanguard charges. Perhaps with as little as $500 M. Then you can spend all your time voting proxies. Even with $500M the number of votes you would get for individual companies would be too little for them to care.

The TLH argument for direct indexing is pretty weak, but it is stronger than the notion that your proxy votes will matter at all.
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by aristotelian » Mon Oct 14, 2019 1:42 pm

nisiprius wrote:
Fri Oct 11, 2019 6:50 am
Suppose that once you have gotten the knack of it you can place a stock trade in three minutes on a brokerage website. Suppose you've made your list of call-it-3,500, or 500, stock ticker symbols, and you have your spreadsheet set up to show you the number of shares you need to buy of each to equal the approximate total you want to buy. It would take you 3,500 x 3 = 10,500 minutes = 175 hours = four 40-hour weeks to buy them. For just the S&P 500, 25 hours, or three 8-hour days.

Personal direct indexing isn't going anywhere until there are user-friendly, automated trading tools to go along with the zero-commission fees. There would need to be some website combining a stock screener to help you assemble a list meeting some criteria, a way to enter the relative allocations, and so on.

With cap-weighting, there needn't be any transactions for rebalancing, but whenever you wanted to buy or sell you would need some way to place 3,500 trades (for the total market), or even 500 trades. If you contribute to retirement savings once a month, that's 42,000... or 6,000 for the S&P 500... trades a year.

There's still bid-asked spread even if there isn't a fee.

In a taxable account there are still tax considerations from purchases and sales and they might get hard to manage if you are doing 42,000 trades a year.

You'd better be sure you have enrolled for electronic statements if every month you are going to create 3,500 line items on your statement.

If you wanted to base what you are doing off a real index, there are interesting issues because index providers charge fees to use their index. So while it might be attractive to someone to say "I want the S&P 500 but without the FAANGs" or "I want Dow Jones Total Stock Market index except for Altria and Tilray," you probably couldn't get access to the index in a direct-indexing tool without paying a fee.

If the mechanism for automatically placing the trades isn't a built-in brokerage feature--if you have to use a third-party app or website to do it--the security considerations are daunting. And imagine a glitch, when push the button to place 500 sales, and 223 of them go through and then something stalls or crashes. And you need to find out which they were, and sell the 277 of them to get the money you needed. And then, of course overnight something comes back to life and finishes the other 277, and maybe you need to hold the cash for a month before buying them back, or create 277 wash sales or something.

And if brokerages are not making money--if they are actually incurring a small loss--on zero-fee transactions, then if third-party direct indexing apps arose, and suddenly thousands of customers were making 42,000 trades a year instead of the few hundred or so they expected, they would probably institute caps and limits... and fees above that limit. Unlimited free trades would turn out to be like "unlimited free data" on cell phone plans.
It seems to me that direct indexing already exists in the form of M1's platform. In the click of a button, I bought $19.14 of ITOT, $13.18 of AGG, $.33 of GOOG, and $.33 of AMZN for my son's allowance money account. You can hold up to 100 stocks per account with unlimited accounts. The minimum buy order is $10, so that means they are processing transactions as little as $.10. Seems to work just fine, although I wonder how much they are skimming from rounding errors.

It wouldn't be hard to set up 5 accounts to direct index the S&P500. In fact, I bet if you search you could find a pre-made pie that someone has created to do this.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by stlutz » Mon Oct 14, 2019 6:52 pm

I think the more realistic scenario here is building one's own multi-factor fund. In other threads some have expressed an interest in only owning the "bestest" stocks--ones that score well on value, quality, momentum, and volatility. Once you try to filter down to, say, the top 40% of each category, you can quickly get yourself down to a few dozen stocks. You then have your own completely perfect factor fund.

Now, if one isn't a factor investor, you can just relax and use VTI.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by mmcmonster » Mon Oct 21, 2019 4:48 pm

MotoTrojan wrote:
Thu Oct 10, 2019 5:11 pm
[...]Can't recall the broker but there is one that has a service for those with larger accounts (>?$500K maybe?) where they will make a synthetic index that aims to track the S&P500 but will tax-loss harvest losing companies and replace them with others in the same industry. Overall it will track the S&P500 somewhat well, while also generating losses for tax credit, even if the overall market never goes down.
Now, this seems like a good use of a computer to do automatically and potentially create value above just investing in an index fund. Has any firm started doing this, and how do they do (after taxes and fees) (compared to a S&P500 or TSM index fund)?

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by MotoTrojan » Mon Oct 21, 2019 6:19 pm

mmcmonster wrote:
Mon Oct 21, 2019 4:48 pm
MotoTrojan wrote:
Thu Oct 10, 2019 5:11 pm
[...]Can't recall the broker but there is one that has a service for those with larger accounts (>?$500K maybe?) where they will make a synthetic index that aims to track the S&P500 but will tax-loss harvest losing companies and replace them with others in the same industry. Overall it will track the S&P500 somewhat well, while also generating losses for tax credit, even if the overall market never goes down.
Now, this seems like a good use of a computer to do automatically and potentially create value above just investing in an index fund. Has any firm started doing this, and how do they do (after taxes and fees) (compared to a S&P500 or TSM index fund)?
I thought it was Schwab. It was one of the big players.


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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by pokebowl » Mon Oct 21, 2019 8:47 pm

snailderby wrote:
Mon Oct 21, 2019 7:21 pm
Was it Wealthfront? https://support.wealthfront.com/hc/en-u ... arvesting-.
Appears they charge 0.25% for the service and there is an additional charge for whatever the expense ratios of the ETFs used to fill any gaps are as well. You'd have to do the math for a large portfolio and see if you still get any beneficial gain from this service after fees and taxes are deducted. Now if these services eventually drop to the passive fund levels, they may be on to something for those with large taxable holdings. You'd keep your voter rights, technically easier to transition to different investing styles depending on the algorithms used, etc.

The issue being of course if you decide to transfer accounts, you will need to transfer to another provider with a similar service, or you end up having to unwind all those single holdings yourself.

If Fidelity or another brokerage offered this with reasonable fees, I'd probably jump on board.
Nullius in verba.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by afan » Wed Oct 23, 2019 4:15 pm

On some financial forum, it may have been whitecoatinvestor, someone reported their experience with an automated TLH service. It produced an 89 page 1099, listing the many security sales for the year. It not only made preparing the tax return a nightmare, it accomplished almost nothing. Apparently many of the sales realized less than a dollar in tax losses.Plus, when the poor investor saw what they had gotten into, the only way out was to drop the service, then deal with the thousands of tax lots on hundreds of securities they were stuck with.

When the alternative is a mutual fund or eft that is effectively free, I cannot see the appeal of direct indexing.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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index2max
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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by index2max » Tue Oct 29, 2019 6:50 pm

Regarding some posts above about how to buy into fractional shares of companies through a stock brokerage firm, it appears Charles Schwab wants to offer this feature in the future. Archived WSJ article linked below.

https://archive.vn/pA6mk

If they did allow clients to buy whole and fractional shares commission-free, my only question is how they'll make money. Do they normally charge any other brokerage fees?

Zerohedge took a dim view of this development and asked whether the Charles Schwab brokerage firm would make money doing underhanded things if they tie their hands behind their backs by charging no commission on stock purchases.

https://www.zerohedge.com/markets/schwa ... ons-stocks

Would they try to front-run clients to make money on each transaction? Would it sell client data to advertisers similar to how Google sells user data?

I'm not an expert on this stuff, so hoping someone that works in the financial industry would know more.
David Jay wrote:
Mon Oct 14, 2019 7:27 am
index2max wrote:
Sun Oct 13, 2019 11:20 pm
David Jay wrote:
Fri Oct 11, 2019 9:47 am
You remind me of the story of the boy walking along the beach, throwing stranded starfish back into the surf. An old man is sitting there observing this and finally speaks up: “You can’t make a difference in ocean life”. The boy replies (as he tosses another starfish back into the ocean): “I can make a difference for this one”.

I feel Ike you are trying to change the ocean. Instead, pick one company and make a difference in their governance. Buy Total Stock with 90% of your retirement portfolio, then take the last million and purchase a nice stake in one micro-cap. Vote your conscience. Maybe even get an occasional meeting with the CEO or Chairman. This will not be symbolic, you may actually make a difference in the governance of the firm.
lol, yes I understand where you are coming from, but considering commissions seem to be going away for individual stock purchases, I was simply trying to figure out where it's now actually possible (and affordable!) for the little guy to do direct indexing on his own.
It is not “affordable” if you assign any value to your time.

[edit] I’m glad you took my point and the spirit in which it was offered. Your idealism is admirable but you - index2max - are not going to change corporate governance by building your own index fund to maintain voting rights. And you will not be starting a significant trend because not one investor in 10,000 will put in the time and effort to follow your pattern. Instead, pick one project in your life where you can make a difference - whatever it may be - and put your time and effort into that one project.
You guys are stretching what I said about voting rights out of proportion. There's no way I could do all the necessary research on TSM companies all by myself! :wink:

Imagine if all index fund investors switched over to a cheap direct indexing platform that charged low-fees and automated the process of following any index you wanted? Then investors could discuss their views of upcoming proxy votes online. People discuss politics all the time and share information before local, state and federal elections. How is this any different in the aggregate?

This is about giving the little guy a say in corporate governance. Not just investment firms like Blackrock, Vanguard or Fidelity etc. running index funds.

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by afan » Wed Oct 30, 2019 9:02 am

There are already plenty of opportunities to debate proxy proposals. Even before the huge rise of mutual funds few investors voted their proxies at all. There are lots of people today who own lots of stock directly and could vote their shares. They could but they don't.

If you really want to vote you could pick those stocks about which you cared, but one share each, and vote. The amounts would be so small that you could ignore the minimal deviation from the total stock market across your portfolio. You would get only one vote but you are never going to have enough votes for the company to care. One vote is as good as 10,000.

Or recognize that you will never influence corporate practice through your proxy votes and worry about something else. Not a reason to do direct indexing.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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Re: If Charles Schwab et al. drop commissions to zero, can we build our own index funds?

Post by alex_686 » Wed Oct 30, 2019 9:51 am

index2max wrote:
Tue Oct 29, 2019 6:50 pm
Would they try to front-run clients to make money on each transaction? Would it sell client data to advertisers similar to how Google sells user data?
Front running? This would be massively illegal. So no.

They can sell order flow. How this impacts you - both positively and negatively - is an ever evolving thing.

Advertising? This data has strong legal privacy controls around it. They would have to anonymized the data. I don't think the market for this data would be particularly deep. The firm would also have to disclose a fair amount of its own proprietary data as well.

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