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Now that we have commission free trading, I am thinking about trying to copy the S&P 400 index or maybe some other index. If an investor buys one share in 200 of the companies that make up the S&P 400 index are there any legal problems doing so. Would he owe any royalties to Standard and Poor? I would think not.

I believe, but I am not sure, that an index fund that mimics the S&P 400 needs to pay royalties to Standard and Poor. Am I right about that?

Note: I am in the United States

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    It you attempt to mimic the index but on a smaller scale, there will be lots of paperwork and possibly more slippage. Buying more or scaling out would be a logistical headache. It might make sense if you have some strategy involving fewer stocks than the index that has historically outperformed the index. – Bob Baerker May 29 '20 at 23:32
  • This will be a lot of work. a) you will have to initially buy the components in proportion to their market capitalization. b) you will have to rebalance your holdings every quarter. This is all because the S&P 400 is a market capitalization-weighted index. – Flux May 31 '20 at 8:06
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Nothing stops an individual or a fund manager from buying and holding all and only those shares which comprise a given index. Consider that many professionally managed funds are closet index trackers in practice so they are essentially "mimicking" the index.

A fund manager pays the index company for the right to use the index name in the title of the fund and its marketing to investors.

(Also note that indices such as the S&P are generally market cap weighted, so buying one share of each of the index constituents will not be mimicking the index.)

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  • You are right on point when you say buying one share does not mimic the index. However, getting the ratio right is hard work. I really like this commission free trading. – Bob May 29 '20 at 22:16
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    @Bob You can read the ratios (weightings) of individual shares on the relevant ETF's website. This will list index constituents and their %-weighting. Still, it's going to be hard work to replicate an index with hundreds of constituents and then have to rebalance periodically. With today's ultra low management fees it may be worth your while to pay a small fee and spend the time you save with friends. – user41790 May 29 '20 at 22:26
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I would also add to other answers is that you have to manage corporate actions, index rebalancing, dividend reinvestment, ...

Hence you are better off owning an indexed fund or etf if you would like to mimic the return profile of a benchmark.

In terms of trading, the weights of an index is a moving target. Hence, you will have to do all trades at market close. I hope you have a trading system that can accomplish that.

Good luck.

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There is no royalty to be paid. For an individual to mimic index would be quite a bit of efforts plus the amount of funds needed to exactly mimic index would be in excess of few millions.

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Some additional info that wasn't pointed out clearly:

You can only buy whole shares, not fractions. Therefore, to mirror a ratio, you are either wildly off, or you have to buy large amounts of shares, which means you need significant amounts of money.

For a simple example, if TSLA trades at 840$ and is supposed to be 0.6%, if you buy even one share, you need a total of 140000$ overall.
Then what do you do if the change to 900$? You would immediately need 10000$ more distributed in the other shares to balance.
If you try to do the math for 400 different shares, you'll need at least a million, and you'll be busy all day catching up for the changes of the previous day, as you need to execute 300 to 400 orders.

There is a reason the index ETFs take 0.02% or whatever, it is quite some work to balance continuously.

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  • -1: This answer implies that an S&P 400 ETF (TSLA isn't in the S&P 400, but never mind) has to rebalance daily due to price movements in the component stocks. This is incorrect because the S&P 400, like most stock indexes, is market-cap-weighted. Holding a fixed number of shares of each stock will properly replicate the index until there is a change in composition. – nanoman May 31 '20 at 0:50
  • The idea that you need to rebalance into other stocks because one stock rose would only apply to an equal-weighted index. And even the S&P 500 Equal Weight Index, for example, is defined to rebalance quarterly and not daily. – nanoman May 31 '20 at 0:51
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    The market cap does change, so the weight of the stock in the index changes. However, without any rebalancing action, the weight of the stock in the ETF's portfolio also changes automatically by the same amount. (Remember, "weight" is itself measured by market value. By definition, a stock holding has 1% weight in a portfolio if the market value of that holding is 1% of the portfolio's market value.) – nanoman May 31 '20 at 23:04
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    Another way to look at it: Say the total market cap of the S&P 400 companies is currently $2 trillion. An S&P 400 fund with current assets of $1 billion holds 0.05% of each company's outstanding shares to achieve cap-weighting. And even as the market prices move, the fund naturally, without buying or selling anything, continues to hold 0.05% of each company's outstanding shares. The return of the S&P 400 index is the percent change in total market cap of the S&P 400 companies. – nanoman May 31 '20 at 23:05
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    Rebalancing occurs once every quarter of the S&P adds/excludes companies and/or corporate actions affecting the index. I do not think you need to rebalance daily because if Tesla market cap goes up 10% in a day, Tesla weight would increase at the expense of other stocks. This would be captured in your portfolio as long as initially held a market cap weighted portfolio. For an equal weighted portfolio, the client or the portfolio owner should set a target to rebalance, let’s say on a monthly basis, in order to return the portfolio to equal weighting. – user28909 Jun 3 '20 at 6:02

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