[by]

Index funds seem to me to work by reducing churn - the percentage of your stock that is sold and bought each year - because every time you sell then buy you lose a lot of money. I am not yet convinced you have to follow an index.

If you had a fund that did not sell anything and bought a random stock from an index as funds came in would this beat an index fund?

[hnhg]

Think of the index fund as reducing the risk of depending on any one stock for your gains. I don't know what the distribution of gains is like on an index fund but an answer to your question would likely come from an examination of one.

[by]

My theoretical fund would have a wide range of stocks. It does not seem to be related to spreading gains or risks.

I have not seen any comparative table of stock churn rates for different funds, but my guess is that index funds do well because they reduce the sell-buy transaction costs, partly by eliminating the cost of human stock pickers, but primarily by reducing the percentage of stocks in the fund that are sold then bought every year. Maybe this is wrong?

My understanding is that an index fund sells and buys stocks to balance the proportions held in the fund as the market capitalisation of the companies changes inside the index. This imposes an apparently unnecessary cost on the fund. If we removed this cost by not selling and buying stocks to keep it equal to the index would the fund become more profitable? I am considering it to be a fund where people invest incrementally over a long period so there would be constant random aquisition of new stocks from the index.

Maybe that doesn't make sense for some reason.

[Benjo]

Balancing portfolios is basically a universally recommended practice. If you manage your own portfolio, won't you have a similar "churn rate" to the index fund?

[by]

"Balancing portfolios is basically a universally recommended practice."

The 'balancing' is against a stock market index which will seriously over-represent a particular geography, industry sector, business size, asset class etc. Why choose that index? Because the stock market tells us to?

"If you manage your own portfolio,"

I was considering how to make a 'passive' index fund even more passive.

"won't you have a similar "churn rate" to the index fund?"

An index fund would have a higher churn rate and therefore higher costs than my theoretical fund, but I do not know how much money an index fund spends on index-following sell-buy transactions.