Take the 2-minute tour ×
Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It's 100% free, no registration required.

I would like to either buy stocks in a fund that tries to follow the Dow Jones Industrial Average index or buy stocks for each component of DJIA and build my own portfolio. Which approach do you think is better?

If I go for the second approach, is it better to buy the same number of stocks from each company or buy stocks for the same amount from each?

share|improve this question
1  
If you want to mimic the DJIA, you need to find out exactly how it is defined. If the DJIA closes at 12400, say, is that the total closing price of shares in each of the companies? average value of 100 shares in each? or the sum of the market capitalizations of the companies divided by the sum of the share outstanding? or something else? and you need to set up your portfolio the same way. Be aware that you will pay extra commissions if you don't buy shares in "round lots" and so investing the exactly the same amount in each company will add considerably to commissions. –  Dilip Sarwate Feb 21 '12 at 15:55
1  
FWIW, most people think it's a bad idea to use the DJIA as your benchmark investment index: (A) it only has 30 companies (!) (B) it's price-weighted, which isn't really the best way to weight your personal portfolio (something like market cap weighting is a better plan). My $0.02 is "you should ditch this plan and invest in VFIAX, it'll give you what you really want (or should want)", but feel free to get a second opinion :) –  fennec Feb 22 '12 at 16:25

5 Answers 5

You better buy an ETF that does the same, because it would be much cheaper than mutual fund (and probably much cheaper than doing it yourself and rebalancing to keep up with the index).

Look at DIA for example.

Neither buying the same amount of stocks nor buying for the same amount of money would be tracking the DJIE. The proportions are based on the market valuation of each of the companies in the index.

share|improve this answer
1  
ETFs aren't the only way to get low expense ratios. There are some mutual funds with low expenses, e.g. VFINX/VFIAX, the latter at 0.06% - personal.vanguard.com/us/funds/… - though, admittedly, there are not so many funds for the DJIA, because as it turns out that's a lousy index to use to weight your investments. –  fennec Feb 22 '12 at 16:28
    
DIA would be the easier answer for tracking the Dow as it'll handle stock-splits and other changes to the index pretty easily as there are times where the Dow does change what is in the index. –  JB King Dec 19 '12 at 22:45

There are only three circumstances where building your own "index" portfolio make sense, in my opinion.

  1. You have some exotic notion for an "index" and none exists yet for it. But unless you're in academic finance or an extremely experienced investor, I doubt this comes up.
  2. You have enough money that the cost of purchasing the shares (the commission you'll pay your broker) is a small part of the overall amount of money you're putting in - notably one lower than the expenses for a mutual fund. For example, using my Charles Schwab account, acquiring the 500 companies in the S&P 500 will cost me $4475. Which means even at a little under half a million dollars being put into the account, commissions are ~1% of my expenses. And that's just the initial purchase - every time you rebalance the portfolio, you're going to incur significant expenses. Either your transaction costs need to be dirt cheap, or you need to be talking about staggering amounts of cash.
  3. You have an abundance of time. Indexes change frequently, need to be rebalanced, evaluated, etc. With a mutual fund or ETF, you're paying someone (or someone's computer) to do this for you. With a portfolio, you're doing this yourself. As Time = Money, the time you spend doing this also needs to be calculated and included in your expenses.
share|improve this answer
    
Excellent. It paints a clear picture to point out the cost and expense of this idea. –  MrChrister Dec 7 '12 at 19:07

One thing I would add to @littleadv (buy an ETF instead of doing your own) answer would be ensure that the dividend yield matches. Expense ratios aren't the only thing that eat you with mutual funds: the managers can hold on to a large percentage of the dividends that the stocks normally pay (for instance, if by holding onto the same stocks, you would normally receive 3% a year in dividends, but by having a mutual fund, you only receive .75%, that's an additional cost to you). If you tried to match the DJIA on your own, you would have an advantage of receiving the dividend yields on the stocks paying dividends. The downsides: distributing your investments to match and the costs of actual purchases.

share|improve this answer

If you are a "small" investor (namely, not an accredited investor), then the transaction costs (commissions) for purchasing the stocks while attempting to duplicate DJIA will defeat any benefit. My personal preference is to purchase mutual funds rather than ETFs.

share|improve this answer

Go with a Vanguard ETF.

I had a lengthy discussion with a successful broker who runs a firm in Chicago. He boiled all of finance down to Vanguard ETF and start saving with a roth IRA. 20 years of psychology research shows that there's a .01 correlation (that's 1/100 of 1%) of stock/mutual fund performance to prediction. That's effectively zero. You can read more about it in the book Thinking Fast and Slow. Investors have ignored this research for years. The truth is you'd be just as successful if you picked your mutual funds out of a hat. But I'll recommend you go with a broker's advice.

share|improve this answer
    
Is there any nuance you would like to address? I like Vanguard too, but surely there are some situations where they are not the best answer. Perhaps you could suggest which ETF, and why specifically that product is superior to building your own. –  MrChrister Dec 8 '12 at 5:03
1  
Oh, you wanted a reason? I had a lengthy discussion with a successful broker who runs a firm in Chicago. He boiled all of finance down to Vanguard ETF and start saving with a roth IRA. 20 years of psychology research shows that there's a .01 correlation (that's 1/100 of 1%) of stock/mutual fund performance to prediction. That's effectively zero. You can read more about it in the book Thinking Fast and Slow. Investors have ignored this research for years. The truth is you'd be just as successful if you picked your mutual funds out of a hat. But I'll recommend you go with a broker's advice. –  Tyler Langan Dec 8 '12 at 5:13
    
You can expand and edit your answer too, not just in the comments =) Address the conversation you had, cite it with some support links to good websites. (You can also address why even Vanguard themselves offers several ETFs for the various situations, and expand your answer to point that out too). Finally, wrap it all in conversation that addresses very specifically the question that was asked. –  MrChrister Dec 8 '12 at 5:40
    
Vanguard is great, but if you'd want to track Singapore's Times Straits Index, you'd have to look elsewhere. –  Tony the Pony Dec 8 '12 at 14:31
    
@TylerLangan I edited in your comment. Welcome to Money.Stackexchange, and take a look at the FAQ sometime. We're generally looking for answers with meat on their bones :-). –  C. Ross Dec 19 '12 at 14:17

Your Answer

 
discard

By posting your answer, you agree to the privacy policy and terms of service.

Not the answer you're looking for? Browse other questions tagged or ask your own question.