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On the hidden costs of passive investing

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  • Iro Tasitsiomi

Abstract

Passive investing has gained immense popularity due to its low fees and the perceived simplicity of focusing on zero tracking error, rather than security selection. However, our analysis shows that the passive (zero tracking error) approach of waiting until the market close on the day of index reconstitution to purchase a stock (that was announced days earlier as an upcoming addition) results in costs amounting to hundreds of basis points compared to strategies that involve gradually acquiring a small portion of the required shares in advance with minimal additional tracking errors. In addition, we show that under all scenarios analyzed, a trader who builds a small inventory post-announcement and provides liquidity at the reconstitution event can consistently earn several hundreds of basis points in profit and often much more, assuming minimal risk.

Suggested Citation

  • Iro Tasitsiomi, 2025. "On the hidden costs of passive investing," Papers 2506.21775, arXiv.org, revised Oct 2025.
    • Handle: RePEc:arx:papers:2506.21775
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    References listed on IDEAS

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    1. Shleifer, Andrei, 1986. "Do Demand Curves for Stocks Slope Down?," Journal of Finance, American Finance Association, vol. 41(3), pages 579-590, July.
    2. Honghui Chen & Gregory Noronha & Vijay Singal, 2006. "Index Changes and Losses to Index Fund Investors," Financial Analysts Journal, Taylor & Francis Journals, vol. 62(4), pages 31-47, July.
    3. Ananth Madhavan, 2003. "The Russell Reconstitution Effect," Financial Analysts Journal, Taylor & Francis Journals, vol. 59(4), pages 51-64, July.
    4. Aditya Kaul & Vikas Mehrotra & Randall Morck, 2000. "Demand Curves for Stocks Do Slope Down: New Evidence from an Index Weights Adjustment," Journal of Finance, American Finance Association, vol. 55(2), pages 893-912, April.
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