Here's a quiet truth about index funds that explains a lot of their success. They're often too dumb to sell. A Heard on the Street column makes the case that this isn't an insult. It's the whole advantage. The stock market's long-run return comes from a small number of enormous winners that more than make up for a lot of duds. The hard part is holding those winners long enough to matter.
Consider Amazon. A split-adjusted dollar paid for a share a quarter-century ago is worth about $250 today. Almost nobody had the discipline to hold through every scary stretch along the way. Even smart, or lucky, professional fund managers usually can't. Risk and concentration rules force them to trim a position once a company gets huge. An index fund has no such instinct. As long as a stock keeps meeting the index's rules, the fund holds it, through booms and crashes alike. That patience, plus low cost, is a big part of why index funds beat most active managers over time.
The rules cut both ways
The column's twist shows the rules also force selling at the right moment. During the 2021 GameStop meme-stock frenzy, headlines were full of amateur traders. Less noticed was a passive fund manager that sold about $1 billion of GameStop, perhaps its biggest single score. Why would a passive firm make such a bet? Because it wasn't a bet. GameStop had briefly grown so large and so overpriced that it no longer fit a small-cap value index, so the rules said sell. "Every index is a set of rules," one of its managers said. Human judgment set the rules once, and then the rules, not a hunch, did the hard thing at the right time.
The lesson isn't that indexes are magic. It's that a clear rule, followed without emotion, beats a smart person's gut most of the time.
Our read
This is an Investments and Risk story, module IN04, and it's the quiet counterweight to a nervous week. We've written a lot in this edition about concentration and about themes falling double digits. All true. But here's the other side. The biggest mistake most investors make isn't owning too much of a winner. It's selling their winners too early, out of fear or boredom, and missing the handful of giant gains that carry a lifetime of returns. Index funds solve that by removing the human who wants to sell.
You don't need to run your whole life by an index. You can borrow its best habit: decide the rule in advance, then follow it instead of your gut. Here are two rules worth writing down this week. First, a selling rule. You sell a holding only when its share grows past a set line, say any single stock above 5%. Or when the reason you bought it is gone. Never just because it rose or fell a lot. Second, a not-selling rule. For a broad index fund, you will not sell on headlines at all. You rebalance on a date. Written rules are how you behave like an index fund when your emotions want to behave like a day trader. We run our model books on rules for exactly this reason, which is why a loud week brought only small housekeeping moves and nothing in the North Star. If you want help writing a simple set of rules for your own accounts, that's a genuinely valuable fifteen minutes.