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School is Now in Session

Published by: Nathan Smith Date: September 12, 2017

Morning fog, garden plants beginning to wilt and wither, the distant echo of high school football practice from my front porch, it must mean that school is back in session. Until my first child started last year, I experienced a relatively calm morning of getting ready, having a cup or three of coffee, and enjoying some local news to get my day started. These days, I am getting up before six in order to get my kids dressed, fed and packed for school. As most parents know, to call it ‘hectic’ would be an understatement. I have some high quality videos of my daughter throwing tantrums that I have stashed away that will be used to embarrass her at some point in the future.  I didn’t realize how much I enjoyed that extra amount of sleep until summer came, and I was able to gain an extra forty-five minutes of sleep each morning.

One thing that caught my attention in preparing for this school year was the ‘Tax-Free Weekend’ that causes everyone in a ninety mile radius to go to Turkey Creek. I never paid attention to it before, since it didn’t affect me. But this time around, it got me thinking about what I would do if I were a patient shopper that didn’t have to buy everything I needed at the same time as everyone else. It wouldn’t be hard to imagine that if the consumers were more flexible when they needed to purchase items for school, that they could find better deals throughout the year on the products needed for the upcoming year. This would allow the consumers to find better values throughout the year, rather than the consumers having to paying higher prices when demand is magnified on tax free weekend.

 

A similar type of event happens in the market, but not many people appreciate it for what it truly is. Every year the major indices in the market (S&P 500, Russell 2000, etc.) do what they call “rebalancing days.” The company in charge of the index issues a press release to the public telling them which stocks are going to be added and removed from their index. They also note in the press release the specific date in which this rebalancing will occur. So the investors that own the inexpensive funds that track the indices (like ones offered from Vanguard), are the shoppers on sales tax weekend.

 

With the list of stocks in hand, many traders attempt and are successful at buying and selling the stocks in the index, and then trade them back to the index funds on rebalance day. The traders know that the demand from investors will be extremely high on that day, and they know exactly which stocks investors will be buying and selling. Laws of supply and demand take over, and the investors end up paying a higher price due to the limited supply of stock available.Index fund investors are saving money via lower fees on their investments and are like the shoppers that save on paying sales tax, but there is an unseen cost to these investors due to how the rebalance of the index is conducted. Other available funds operate based on proven academic research and perform better than the indices (like ones offered from Dimensional Fund Advisors) employ patience and flexibility around when to buy and sell stocks that are in their funds; Just like the shoppers who are patient acquiring the items that they need for school finding by the best sales on those items and avoid the increased demand from tax-free weekend.

 

Index investing has certain advantages over other forms of investing, but personally I would rather invest in funds that beat the indices and are patient and methodical about buying and selling stocks. Funds that aren’t forced to buy and sell when the demand is highest allows for overall cost reduction over the long-term, leaving investors with more money in their pocket.
 

 

Nathan Smith is Portfolio Manager at Rather&Kittrell, and can be reached by email at nsmith@rkcapital.com.