On the hidden costs of passive investing
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.
Keywords
Cite
@article{arxiv.2506.21775,
title = {On the hidden costs of passive investing},
author = {Iro Tasitsiomi},
journal= {arXiv preprint arXiv:2506.21775},
year = {2025}
}
Comments
v2-Introduction: expanded to incorporate additional empirical evidence from recent studies that further substantiate the motivation and real-world relevance of the work. Discussion and Conclusion: included illustrative price path linking the modeling framework to observed data and estimates of the performance drag. All other sections and results remain unchanged