Advanced Capital & Investments · By-product guide
Index funds: the market, at the lowest cost to own it
An index fund does not pick stocks. It buys what is in an index, in the same proportions, and changes only when the index changes. That makes it the cheapest by-product of the core, until other layers are added on top.
Education only. We explain how these products work and what they cost. We do not sell or recommend securities.
Why index funds took over
Stocks and bonds, bought by rule
Same index fund, different total cost
The fund itself can cost almost nothing. What changes the result is what is wrapped around it: a retail share class, an advisory fee, a wrap program.
| $100,000 for 20 years at 7% before costs | Yearly cost | Value at 20 years | Lost to costs |
|---|---|---|---|
| Index fund on its own | 0.05% | $383,117 | $3,851 |
| Same fund inside a 1% advisory or wrap account | 1.05% | $313,322 | $73,646 |
Hypothetical. 7% gross a year, costs applied yearly, no taxes. Not based on any actual fund or account.
The manager, the product and the sales force are often three different firms
Retail investment products are usually layered. A money manager runs the portfolio and its research. The product is packaged and branded by a sponsor. It reaches you through a sales organization, often a separate, unaffiliated firm with no research department of its own, which is why the investment work is farmed out to a third party. Each layer is paid, and the person presenting the product is usually not the person managing it.
Pooled products are also built to stay invested. Funds commit in their prospectus to a strategy, often at least 80% of assets in what the name describes, and are judged against a benchmark. A manager who sees a major risk coming usually cannot step aside the way the owner of individual stocks and bonds can.
What GIPS tells you
The Global Investment Performance Standards (GIPS), created by CFA Institute, set out how investment firms calculate and present their track records: every actual, fee-paying portfolio included, at least five years of history building to ten, and compliance across the whole firm. They are voluntary, and only firms that manage actual, discretionary assets may claim compliance.
A sales organization that does not manage money has no track record to present and cannot be GIPS compliant. When you are shown performance, ask whose it is: the manager’s audited record, or a sales illustration.
Source: CFA Institute, Assistance to Firms Considering Compliance with the GIPS Standards; gipsstandards.org.
Questions to ask
- Which index does it track, and how is that index weighted?
- What is the fund’s expense ratio, and what am I paying on top of it?
- How closely has it tracked its index after costs?
- How much of the fund sits in its 10 largest holdings?
- Is this the lowest-cost share class of the fund I can buy?
- Am I paying an advisory fee to hold a fund that needs no research?
Advanced Capital & Investments pages are for education only. Nothing here is an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or investment strategy, and we do not sell securities through this site. Examples are hypothetical, do not represent any actual product and do not reflect taxes unless stated. Investing involves risk, including loss of principal. Before investing in any fund, read its prospectus and talk with a properly registered professional.