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Fund Spy

How Two Vanguard Index Funds Kept Up With the Times

Meanwhile, one of their siblings is still living in the past.

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With index funds, you know what you own. They have their portfolios, which mirror their benchmarks, and they stick with them. No need for shareholders to worry about an active manager taking bold bets that backfire.

At least that's the popular impression. In reality, index funds do change. At the most basic level, they must adjust their portfolios when indexes make their regularly scheduled alterations, called "reconstitutions," or institute even larger revisions. For some indexes, those alterations can have a surprising impact. As just one example, in late 2004, Dow Jones made sweeping changes in its Select Dividend Index, doubling the number of stocks and altering some of the rules for inclusion. Then there are unscheduled events: mergers or bankruptcies that force indexes to change a component or two.

Even more substantial, though, are the changes that the fund companies themselves initiate. Typically these involve swapping one benchmark for another, or with funds of funds, tinkering with allocations. The histories of three Vanguard international index-trackers show how timely adjustments can be useful or even necessary in some cases, and how an index fund that's too passive can end up out of step.

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