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ETF Specialist

The Hidden Costs of Indexing

Picking the right index could matter more than an index fund's expense ratio.

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On Jan. 26, 2010, Standard & Poor's announced that Berkshire Hathaway would be joining the S&P 500. A curious thing happened: Berkshire's stock rocketed to around $76 from $68 in a few short days, a nearly 12% rise. Did S&P's pronouncement increase Berkshire's intrinsic value by 12%? Warren Buffett would say no.

What changed was that now everyone knew a chunk of the one-trillion-plus dollars indexed to the S&P 500 would move in lock step to buy Berkshire stock on Feb. 12. Naturally, hedge funds and traders rushed to buy the stock before the inclusion date. When the day rolled around, the index funds obeyed their mandates and bought more than $20 billion worth of Berkshire Hathaway stock at a 12% premium. It was a $2 billion payday on the index investor's dime.

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Samuel Lee does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.