> What if the algorithm Vanguard uses was open sourced and could be self-hosted by independent investors?

It already is "open sourced". Vanguard precisely discloses what's in each of their funds already [0].

The issue with independent investors perfectly replicating the securities underlying the index funds is that the vast majority of investors simply don't have enough capital to replicate the underlying components of the fund. Meaning, the typical investment amount of a randomly chosen investor cannot buy enough shares in proportion to each other to be as diversified as a massive $100+ billion fund. That's before discussing the issues with maintaining a balanced portfolio.

> Where each investor owns their portfolio outright and adjustments to the portfolio are made automatically by a free index manager bot that runs the simple algorithm an index fund manager like Vanguard would.

If you had enough capital and trusted such a bot enough, it's not hard. But the vast majority of people will never have enough capital.

[0]: See about 40% of the way through this PDF for the securities behind Vanguard's Total Stock Market Index Fund: https://personal.vanguard.com/funds/reports/q850.pdf?2210151...

Presumably if you replicate the holdings you are lagging their buys and sells. The lag could cost more than the fees so you might as well but the fund instead of replicating...

With free trades (now in everywhere) and fractional share purchases(robinhood), I think buying your own S&P500 fund would be possible with little capital ($1000?), and easy if your broker set up the software on their system to do that. I would not be surprised if robinhood already has this feature.

Why not just buy SPY? The expense ratio is only 0.09% and it's one security to track.

Given $1000 to invest, I can't fathom trying to individually own an average of $2 worth of each of 500 companies. And that doesn't even begin to cover it. Because the S&P 500 is market cap weighted, you would need to own $45.70 of AAPL, the top company. I don't know what the 500th stock is, but you'd probably need to own about $0.10 of it.

Even if trades themselves are "free", you still need to pay something like $0.13 per trade in SEC fees. So you are paying about a 100% commission on each of the smallest stocks you buy. And then another 100% commission when those stocks fall out of the index and you sell.

Just buy SPY. There are many good reasons that it has grown to $307 billion in net assets.

There are robo advisors who will buy the individual securities in indices for you, as long as you have enough invested with them (50k? I forget). But the only advantage over simply buying the fund AFAIK is being able to tax loss harvest from the higher volatility of individual securities. Eg, if your two-security index has stock A go down 5% and stock B go up 6%,an index fund would simoly go up 1% while the actual basket would allow harvesting the losses from stock A.

As far as I can tell, this is a fairly minor advantage, and if I wasn't using a robo-advisor, i certainly wouldn't be managing the basket directly just for this ability.

I think there are a handful of problems with this post, one of them being that index funds are already in many ways "open source." Re: their investment choices the investments that go into an index are chosen by the creator of the index which is separate from the investment house. The investment company MUST simply follow the index and trade as the index indicates. The tracking accuracy may vary slightly between Vanguard, Blackrock, and others, but generally they're all tracking accurately using basically the same methods. Any investor can move their shares to any other investment house at any time.

Also each investor already owns their portfolio outright... it is simply housed at the investment company. There is an absolute avalanche of regulation making that not just desirable but necessary. To remove a brokerage house from this equation would first require the complete and utter destruction of the global economic system (highly unlikely).

Every investor has the ability to choose funds crafted based on moral guidance or active management, which would spread out voting power more than it currently is. People are by and large not choosing that option at the moment.

Isn’t one of the concerns that index funds are supposed to mimic the index’s returns, but absolutely aren’t required to track the index holdings?

If absolute rebalancing was required in an S&P 500 index fund, there would not be enough liquidity in the market for some of the smaller of the 500.

It’s all been fine and well during a bull market, but a concern is that “index” funds have huge amounts of synthetic holdings that are untested in a rout.

The average investor’s portfolio wouldn’t be large enough for them “self host” their own index fund. Most people probably couldn’t afford to buy even 1 share of each of the underlying companies their index fund holds. There’s also a lot of work/judgment calls that are made in the rebalance process and with corporate actions and such. Granted, not nearly enough to justify most of the fees. But unfortunately (as it stands right now at least) the only way the index fund really works for retail investors is by way of pooling money.

All that being said, I’m optimistic someone can come along and find a way to shake the industry up. The status quo is great for the investment industry and pretty shit for everyone else. Tale as old as time.

The actual mechanics of owning the shares is incredibly complicated. It’s unlikely that any of us have index fund holdings that represent integer share counts.

Handling stocks when they move in and of the index without spiking the price is a finely calibrated, high skill trading desk action.

There are huge economies of scale in finance as well. The time it would require you to maintain the index would most likely cost you more than the management fee on the index.

Your brokerage software could make this easy. E-Trade could have a feature where you can buy/sell the S&P500, Russel2000, or total US index. You put in the total amount to invest and it does the rest.

It already exists. It's called an index fund.

That's obviously not what the parent comment is talking about, since they're holding it in contrast to index funds. They're talking about directly holding the securities involved.

Roboadvisors do actually offer this if you have enough money. The only advantage AFAIK is being able to tax loss harvest the greater volatility from individual securities.

Fractional shares are synthetic, so you can't vote them. At that point the way to do it is to have an index fund with bylaws that it votes shares as the members want.

It is "open sourced"...you can go to any index provider, and they will tell you what is in the index...you realise that there is no complex "algorithm", it is just a market-cap weighted index (and even then, you can replicate the perf of these indexes with 10-20 stocks).

And this has already been invented. It is called hub-and-spoke, you generally see this with small CTAs and the like where there is a central portfolio with trades mirrored into separate accounts...it works but it is unnecessary, and costly. Another example of is are those awful portfolio mirroring services (eToro is one I think).

Btw, the thing that you are saying is "free" is where all the cost is. Yes, it would be great if everything was just "free" and people would do things for me for no money...but that isn't realistic. Some companies do just provide the "investment" side without all the low-level trading/account management/customer-facing stuff but it usually isn't attractive to do so for individual investors...this is basically what the big pension fund consultants do.

Marketing to individual investors is utterly hellish. It is expensive and the money you obtain is usually pretty worthless. If you are actually have investment talent, it is a terrible financial decision. You can spend hours pitching for pocket change with retail investors or you can make the same in a few seconds with an institution.

Wow! Thanks for all the replies. Glad other people found this silly idea interesting.

A lot of the issues that were brought up have to do with fees associated with purchasing all the stocks and the fact that you would have to buy very small fractional shares. Certainly big issues today but they don't sound like showstopper problems to me.

And to the folks criticizing my lazy use of the term "open source" - I apologize. I should know better using that phrase on hacker news!

To clarify: clearly the market weighted index process is a well known and very simple algorithm. What I meant by "open source" was a tool that can employ that market weighting process and handle all of the financial transactions necessary to execute all of the trades.

I think the problem with this would be brokerage fees for buying/selling. If a fund is rebalancing 10% of their holdings the fees are a rounding error, if I'm rebalancing 10% of mine as an individual the fees would be a noticeable percentage.

There are no brokerage fees anymore.

But fractional share ownership is not widely popular and would require an aggregator anyway.

Are you aware of a firm that offers free trading in fractional shares?

Robinhood announced that and you can request early access to it in the app right now. And yes, it is commission free too.

Square cash?

https://www.theverge.com/2019/10/24/20930659/square-cash-app...

M1 Finance, Interactive Brokers

So for a lot of shares that people can only afford fractional ownership of some kind of fund would still have to own them?

One reason is because an individual investor has to go through a broker-dealer in order to trade and that usually has fees associated with it. If retail trade volume went up, you would see those fees rise.

Sounds like M1 finanace’s pies to me. Since M1 has fractional shares, creating your own index is relatively easy even with little capital.

It would work, except there's nothing in it for the users. So people won't adopt it.

Having spoken with few people, the process is still mostly people, building algorithms in Excel. Much of what drives decisions is research, and personal decision's, not automation.

I've heard AI trading has done very poorly as the system isn't predictable, it's people making decisions in ways which can become self fulfilling prophesies.

Algorithms when distributed would also fall victim to the fastest person benefiting the most

An index fund isn't doing research or making decisions though.

They invest in companies that make up an index. When a company enters the index they buy units in that company, when a company leaves the index they sell those units.

But this is not supposedly true for index funds by definition. They are passive. They just buy whatever is in the index. No other decisions made.

What sorts of things do you track and model in Excel? I've been looking at fundamentals and the business landscape. What should I add?

> I've heard AI trading has done very poorly as the system isn't predictable

So have humans, which is one reason index funds exist.