Archive | October, 2015

Are Index Funds Fatally Flawed?

“No one pretends that democracy is perfect or all-wise,” Winston Churchill famously said in a 1947 speech. “Indeed, it has been said that democracy is the worst form of government except all those other forms that have been tried.”

I recalled this bit of wisdom recently when two readers sent me links to articles that question the safety of index funds. Both identify genuine flaws in traditional cap-weighted index funds. But the problem—as always—is that the alternatives turn out to be worse. In this post, I’ll look at some of the arguments levelled at equity index funds. Next time, we’ll turn the focus to bond indexes.

Earlier this month, the venerable New York Times ran an article called The Ease of Index Funds Comes With Risk. The piece acknowledges the many benefits of index ETFs but then warns that “their simplicity harbors some simmering problems, which have grown more troubling in the course of the bull market in stocks.” It goes to say that “cracks in the edifice of passive investing are beginning to show.”

Experts in the article are concerned that the mere inclusion of a stock in a major index—particularly the S&P 500 of large-cap stocks and the Russell 2000,

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Vanguard’s New World Order

If you follow my model ETF portfolios, you may have noticed that one of your holdings has a new name.

The Vanguard FTSE All-World ex Canada (VXC), launched in the summer of 2014, is a simple, low-cost way to get exposure to stocks in the US as well developed and emerging markets overseas. Now VXC has evolved to cover even more of the global equity market, and further expansion is planned for the coming months. To reflect these changes, the fund recently changed its name to the Vanguard FTSE Global All Cap ex Canada Index ETF. The ticker symbol remains unchanged.

VXC is an “ETF of ETFs” with four underlying holdings: the Vanguard Large-Cap (VV), the Vanguard FTSE Europe (VGK), the Vanguard FTSE Pacific (VPL), and the Vanguard FTSE Emerging Markets (VWO). The latter three ETFs recently adopted new benchmark indexes that include small-cap stocks as well as large- and mid-caps. As a result, the total number of stocks held by VXC has swelled from just over 3,000 at the end of August to more than 5,100 today.

The addition of all those stocks makes VXC more diversified than ever,

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