And the relative values of those stocks will shift requiring rebalancing. You might be able to do that with new dollars for a while but hopefully, eventually, the swings are much more than new dollars and then what? Pay capital gains tax on sales to rebalance? Convince yourself the new random allocation is fine?

I thought the point of index funds weighting by market cap is that they don't require rebalancing, because the weight of stocks in the index exactly tracks price movements. You just keep holding the exact same number of shares, and more valuable stocks automatically take up more of your portfolio.

Yes, this is one of the benefits of a cap-weighted index fund.

It doesn't eliminate the need for the fund to rebalance, because of companies moving in and out of the index criteria.

But it certainly vastly reduces the need of the fund manager to trade.

(Also, stock buybacks and new share issuance should in principle not change a company's index weight, but in practice they sometimes do.)

(deleted)

If you pick stocks with the correct weight to track the index, you're effectively running an index fund. And so you don't have to rebalance to keep tracking the index.

1 If you never rebalance, you're never adding new stocks to the index, nor removing stocks that do not belong to it anymore.

2 You need to rebalance to take corporate events into account: new stocks, buybacks, dividends, etc...

You can add stocks whenever you put money in. Whether that's because you got your paycheck or a dividend or some other income is kind of irrelevant. And you can remove stocks when you take money out. But you probably shouldn't start selling one stock to buy another just because their prices moved, unless you have information that lets you time the market.

But then you wind up with a portfolio that isn't balanced and isn't tracking like an index fund. An index fund doesn't simply buy a flat amount of stock and hold it, they buy stock in proportion to the relative weight of the exchange. Which is always moving

Market cap weighting is special. If company A has 500 shares, company B 500 also, than a fund that has 5 shares of A and 5 of B is market cap weighted.

And what happens if company A issues more stock? Company B is delisted? Company C is now listed? Company A and C merge? Company A spins off it's most valuable side business into it's own independent listing company?

Most transactions just getting the results is all you need

This is only true if those 500 shares had identical value, as market cap is the number of shares x the price.

They do have identical value.

500 shares of company A is worth 100% of the market cap of company A.

500 shares of company B is also worth 100% of the market cap of company B.

So if you have 5 shares of each, you'll have 1% of the market cap of each, even if one of those companies finds the cure for cancer or turns out to be a money furnace.

Indexes rebalance frequently. The "correct weight" today, won't be the correct weight in a year.

What are you talking about? Those index fund are constantly rebalancing. This is why you buy an index fund, so you don’t have to constantly rebalance your portfolio.

Philanthropically-minded people will move the winners to a donor advised fund which gives FMV write off without ever paying capital gains.

With index funds you never have the strong winners to do this with, and so giving is far less tax-efficient.

I don’t think this is correct. Gains historically accrue to a small number of companies in a given time window. If you buy all the grocery stores, you’re exposed only to sector risk, if you pick one or two, you’re also exposed to the risk those companies don’t contain the “winners”.

I suspect the number of picks you would need is surprisingly small to reach high parity with the S&P.

If you don’t pick the right grocery company, you have a shot at picking the right telecommunications company. You pick fewer winners, but you’re also picking fewer losers.

The real reason to do this is because you want to avoid specific companies that are inside the index. You would only do this if you felt confident in your ability to avoid investing a lot of capital in losers. Even if you’re great at avoiding the telecommunications loser, you might be worse than average at avoiding the loser in other sectors.

I don't know about the typical HN contributor but I personally lack the cash to but all the stocks in the S&P. There are 503 stocks tracked in the S&P 500 index. It would cost about 2.8 million USD to buy 100 shares (one board lot) of each if you were naive enough to weight your purchases that way. If you were to weight the stocks differently (eg. total market capitalization of each company) the amount would be higher.

Or, I can pick up 100 shares of an index ETF for a few thousand and have someone else do all the work for me including rebalancing and doing all the other required calculations (lot tracking and cost basis calculations etc.).

Trading in lots of 100 hasn't been required since I dunno, the 90s?

Assuming you're in the US there are several competent brokers that sell fractional shares. Any broker will do lot tracking and cost basis calculatioms for you, they're required to.

Rebalancing might be a pain, yes. I'd bet the drift isn't too bad most of the time, but it's probably effort every time you add or remove money. You'd want to build a tool to tell you how to add and remove to get closer to the index. If you can get the index weights and your holdings in a machine readable format, it would seem pretty tractable, but it would take time to setup; there's a reason funds have expenses, but index fund expenses are small.

I'm 100% invested in funds because it's a lot less work, but if you felt strongly about excluding certain stocks, I think it's pretty doable for say S&P 500. Tracking a total market index, or an international index would be more challenging. Bond indexes are also challenging to track, even for bond funds.

Interactive brokers offers fractional shares I'm sure other brokers do as well.