A stock index is meant to track a basket of stocks. The S&P 500 is a famous one. It tracks a group of 500 of the largest and most influential U.S. stocks, making it the benchmark indicator for equity performance. Ask someone "how did Wall Street do today?" and they'll likely tell you how much the S&P 500 moved.
While it represents a high-profile case study, the S&P 500 is just one example. There are hundreds of stock indexes, each targeting different baskets of stocks. Some follow general market performance (the S&P 500, the Dow Jones Industrial Average). Others target specific industries or particular market cap sizes (small cap, mid cap, etc.).
These indexes are fundamentally mathematical constructions. We say they track "baskets of stocks," but it's not like there's an actual basket somewhere. As such, there can be some space between the theoretical performance of stocks in an index and the performance of the actual stocks that underlie that index.
Index arbitrage looks to profit from these potential gaps in performance. An investor would buy (or short) a futures contract based on a particular index, and then take the opposite position in the actual stocks that make up that index. The theory is that, over time, the little mispricings that happen in the index system will work themselves out. The gap will close. When it does, the arbitrage position will squeeze out some profit.
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Finance: What's the Difference Between M...121 Views
And finance allah shmoop what's the difference between mutual funds
and index funds The answer this guy or well this
team what do they do They manage the mutual fund
mutually together You know what nemo They make bets on
apple and amazon in crotchless tuxedo pants Dot com will
these bets or into teligent investments In the parlance of
the industry our elements oven actively managed fund The mutual
fund is active in that it buys and sells hoping
to be smarter than the market and find areas you
know where they're inefficiencies where investors are throwing out the
baby with the bath water so that they buy the
shares here a twelve bucks and hope to sell them
if they hit thirty bucks in two years when the
new products get released and people are going absolutely bonkers
for self velcro ing neckties or whatever and index generally
stands pat on the hand It's dealt throughout the course
of the year making only small tweaks to invested amount
so that the fund itself conforms to the structure or
rules it set out when it was created But there
are a few vital and insidious differences that should make
investors today very wary about investing in mutual funds or
any actively managed fund When mutual funds first became popular
the investing marketplace was kind of the wild wild west
that was the nineteen fifties and sixties and a savvy
fund manager could beat the market by five and even
twenty percent per year year over year It was kind
of a golden age of mutual funds and money flowed
into them But like all good things this market wrinkle
easy winds and the investing world had to come to
an end Why competition when there were only a few
mutual funds out there and a few private investors it
was relatively easy to identify baby bathwater things you know
diamonds in the rough Today there are literally thousands of
mutual funds With such massive competition performance relative to the
market has lagged dramatic In fact over a typical seven
to ten year holding period only a very small handful
of mutual funds beat the typical index fund investing in
the same or analogous areas of stocks or bonds It's
like one in twenty ever really beat the market and
it gets worse Mutual funds charge relatively large fees compared
With index funds whereas a typical index fund might charge
twenty basis points to manage your money that is twenty
cents for every hundred bucks you have with them for
year The analogous mutual fund My charge One percent or
more that's five times surprise for demonstrably no better investment
results and wait It gets even worse Mutual funds trade
stocks and bonds and other securities index funds rarely trade
or if they do it's a very small amount of
trading around the margin keeping index in compliance with its
legal charter But many mutual funds have turn over the
apple variety of like fifty eighty or even one hundred
percent Turn over means that a fund has sold the
stock to realize a taxable gain You know book a
profit by taking cash from selling the stock or to
realize a loss sometimes as well we'll each time of
fund transact It pays a commission to our friendly excellent
golf skilled brokers but more painful to most investors is
that in transacting the fund realizes taxable game So what
does that mean Well here's the math If your mutual
fund is up twelve percent given year when the market's
up ten percent it would be an absolute top of
the pyramid performance here For the fun of beating the
market by two hundred basis points would likely mean that
mutual fund was in the top forty right up there
with rina's latest it single So what is that awesome
performance after tax for the mutual fund Well if the
fund had traded like the typical one it would have
had turnover of about sixty percent of its assets and
half of those sales would get ordinary income tax treatment
think high rates of something like forty percent with federal
and state taxes combined for most and long term gain
of twenty percent for the rest Well the wealthy pay
higher taxes so we're rounding down the numbers here even
being conservative So if half of the sixty percent or
thirty percent of the gain of twelve percent which is
around four percent his tax at forty percent then take
away one point six percent from the performance to get
an after tax net result number Then after another thirty
percent tax at the long term gain rate of twenty
percent you'd have take away another point six percent so
in total you'd have to subtract one point six plus
point six or two point two percent from the twelve
percent humongous rock star year to net nine point eight
percent in after tax returns Nope not very exciting relative
to that index fund And yes there are differences here
even important ones But the bottom line is that if
a huge performance top two percent fun has results Not
much better and or maybe worse than just a basic
index funds Why does anyone invest in mutual funds anymore 00:04:49.487 --> [endTime] Well this guy
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