A new blog, Behavioural Investing, by author and investment industry professional James Montier has a worthwhile post titled Something the Bogleheads wouldn't want you to know, or index investing isn't passive. The posting reviews a research article called Index Rebalancing and Long Term Portfolio Performance by Cai and Houge. Montier's provocative headline (are the adherents of John Bogle annoying people and causing others to want to poke holes in their balloon?) states that indices such as the S&P500 and the Russell 2000 are not passive. Well, that turns out to be merely a reflection of the fact that companies are added or dropped from the index on a regular basis. Big deal, that's what an index is. The important point is that better returns and lower risk could have been achieved merely by buying and holding the original members of the index. Montier cites another paper by Siegel and Schwartz, The Long-term Returns on the Original S&P 500 Firms, that finds the same thing as Cai and Houge.
The challenge now is turning that research result into a practical investing strategy. Buy and hold is obviously the core of such a strategy as Montier says at the end of his post. But what exactly to buy and hold? An individual, Warren Buffett aside, cannot buy all 500 stocks in the S&P 500. I haven't come across any Exchange Traded Funds out there that implement the ultimate buy and hold. In the meantime, those index ETFs still seem to be the best available practical investment vehicle. Little is ever perfect, even index investing, which is an encouraging thing since that means there's always room for improvement and it is worth the effort to find those improvements.