The DIY Investor's Guide to Building Your Own Index Fund (And Why It's a Terrible Idea)

Tyler Gardner (0:00)

Acknowledge that you may not beat the S&P. Acknowledge that your homemade stew, well being good, may lack the polish of a Michelin chef. But also acknowledge that in the act of cooking, you've learned more than the diner who simply ordered takeout or read about the latest culinary trends online. The S&P and its cousins are master works of design honed over decades. If you do go your own way, do it for the education, not the edge.

Hello friends, this is Tyler Gardner, welcoming you to another episode of Your Money Guide on the Side, where it is my job to simplify what seems complex, add nuance to what seems simple, and learn from and alongside some of the brightest minds in money, finance, and investing. So let's get started and get you one step closer to where you need to be.

I want to start by having you imagine walking into a hardware store and announcing with great confidence, you know what, Home Depot? I'd like to build my own refrigerator, please. The clerk would probably stare at you for a moment, hand you a wrench, and wish you the best of luck. That's more or less what it's like when an investor decides to build their own version of the S&P 500, or any fund for that matter. Technically, it's possible, admirable even, but also the sort of thing that ends with a lot of loose screws and an ice machine that will make a ton of noise and produce very few ice cubes. So in this episode, we're going to talk about the peculiar urge that many people have to build their own fund. I've had this urge. I've acted upon this urge. And I've spent years working with my own funds, and honestly, I've had a lot of fun along the way and learned a ton about what works, what doesn't work, and what bluntly is incredibly redundant as there are already passively managed funds doing way more than I could ever or would want to ever do on my own. So we'll talk about why someone might want to do this, how you could go about it step by step, and why even if you never actually follow through, the exercise or at least having the knowledge is worth your time. Because beneath the sleek, efficient surface of your average index fund is a world of sectors rebalancing and hidden decisions that most investors will never see or know about. So as always, the goal of this episode is to help educate, to make it a little less than absurdly boring, and to give you some practical tools that may help you in the next step of your investment. Investing journey. Now, before we get into it, my weekly ask, if you are enjoying the podcast, if you've ever found yourself laughing, groaning, or even rethinking your portfolio after one of these episodes, please consider leaving a review on Apple Podcasts. Or better yet, share the episode with a friend, especially that friend who swears they're just about to start their own hedge fund. Reviews and shares are the easiest way to get this show in front of more people, and I'd be, and I already am, incredibly grateful. Here's the central tension of today's episode. Building your own fund sounds like a way to avoid even incredibly low fees, and to take even more control of your own investing. But index funds, like those that track the S&P 500, are already doing more work behind the scenes, than most people realize. The S&P isn't some sleepy set-it-and-forget-it relic. It's an actively managed list, even though it's called a passive index, constantly pruning and adjusting. A financial version of The Wizard of Oz, where you eventually discover there's a committee pulling levers just out of sight. Still, building your own fund, or even just learning about how to do it, teaches you something invaluable. You learn how different sectors actually behave. Why technology is like Gatsby, glamorous but volatile, while utilities are more like Jane Austen, unflashy but relatively enduring. You see how benchmarks are constructed, how factors like value and momentum can add seasoning to your portfolio, and how much ego sneaks into your decision making when you start tinkering. Most importantly, you see just how efficient and tax smart the humble index fund really is. And maybe that's my goal here, to show us all, time and again, as frequently as possible, that I have yet to find any way to invest that beats investing in a few boring index funds and calling it a day. Throughout this episode, we'll walk through five steps to designing your own fund. Number one, we'll start by introducing you to sectors, understanding the 11 drawers the market uses to file every single company. Number two, we'll talk about researching what are called benchmarks, peeking under the hood of funds like SPY and VOO that track the S&P 500, and we'll see what the pros do and what you're ultimately comparing yourself to. Number three, we'll talk about what's called tilt, which means just adding a little more flavor than what's in the S&P 500, and we'll talk about tilting with purpose, whether it's by adding value, growth, or sector seasoning without turning dinner into a Dostoevsky novel. Then we'll build the fund. We'll use sector ETFs to create your own S&P clone and discover why rebalancing can actually become a full time job, finally, we'll talk about how to keep costs down and your ego in check, and we'll learn why the index is way more active than you think, and why humility may be the cheapest and most practical asset you could put in your portfolio. By the end of this episode, you'll either be ready to launch the Tyler Gardner Growth Fund, coming soon to a brokerage account near you, or you'll throw up your hands and say, fine, I'll just buy the index. Either way, I promise you this, you'll walk away from this episode smarter, more informed, and if all goes well, maybe slightly entertained regardless. So let's begin. How to build your own fund, and why the real lesson might be that you don't need to. Know your sectors. If you're going to build your own fund, the first step is understanding the pieces on the board. The financial industry, being the orderly librarians they are, has divided the entire stock market into 11 neat categories called GICS sectors, Global Industry Classification Standard. It sounds good, but really it's just the market's filing cabinet. Every company gets put in a drawer somewhere, whether it's Apple under technology, or Duke Energy under utilities. Here are the 11 drawers or sectors. Information Technology, Healthcare, Financials, Consumer Discretionary, Consumer Staples, Energy, Industrials, Materials, Real Estate, Communication Services, and Utilities. Together, they cover just about every way human beings can find to make or lose money. Now, each sector, unsurprisingly, has its own personality. If the stock market were a novel, as mentioned above, technology would be gatsby, glamorous, full of promise, prone to throwing wild parties, and having equally wild crashes. Consumer staples would be more like George Eliot, steady, grounded, more concerned with bread and butter than fireworks. Energy often plays Heathcliff, brooding, volatile, capable of both passion and ruin. And utilities are the Jane Austen's of the market. They may not move quickly, but they're quietly reliable, endlessly re-read, and always seem to survive the trend cycles. The point here isn't to get poetic, though that certainly helps on long trading days. It's to understand that sectors behave differently depending on the decade you're living in. In the 2000s, energy had its moment. Oil was booming. ExxonMobil was practically writing the script. Then came the 2010s, the tech decade, when Apple and Microsoft turned into trillion-dollar behemoths, and anything with an app seemed destined for glory. Consumer staples, your Procter & Gamble and Coca-Cola's, tend to shine in downturns, when investors prefer toothpaste and soda over electric vehicles and crypto exchanges. In other words, the key here is that sectors rotate, even if you think one sector is forever here to stay. They take turns leading and lagging. Fidelity puts out annual sector performance charts that I would encourage you to look up, that look like multicolored subway maps. Tech surge is one year, energy the next, healthcare weaves through like a dependable bus route. If you're going to construct your own fund, you need to start by deciding how much of each sector you want in your basket. Are you building a replica of the S&P? A little of everything, weighted by size? Or are you making a bet that certain sectors will outperform this year? This is the definition of active portfolio management. This is also where temptation starts to creep in. Because if you know tech crushed it last decade, why not overweight it now? If utility seems boring, why would I bother at all? The problem is that history has a bad habit of punishing certainty. Energy stocks were darlings in 2008, dogs in 2014, and then had another rally in 2022 Tech has rewarded patience, but also inflicted the.com crash. Consumer staples are dull until suddenly you realize dullness was exactly what you needed in a recession. This is why professional fund managers obsess over sector allocation. The composition of your portfolio, how much you put into each drawer, is often way more important than the individual names inside. Owning Microsoft instead of Apple is far less significant than whether you own enough technology at all. Likewise, choosing Coca-Cola over Pepsi matters way less than deciding how much of your portfolio should be consumer staples in the first place. So, the first step in building your own fund is to map out these 11 sectors and recognize their cyclical natures. Each one has moments when it looks like Shakespeare's Hamlet, tortured, misunderstood, and doomed. And other times when it struts like Henry V, conquering everything in sight. The art of asset allocation and of building your own fund begins with knowing these characters well enough to cast them wisely. And remember, even the S&P 500 itself isn't neutral on this question. Its current composition is roughly 27% technology, 13% healthcare, 12% financials, and the rest spread more thinly across the other sectors. So when you buy the market, you're not buying an equal slice of every company. You're buying a novel with certain characters in bold font and others relegated to the margins, or even, dare I say, David Foster Wallace-style endnotes. And we all know most of us aren't reading those anytime soon. So that's your challenge in step one. Learn the cast, study the cycles, and decide how much you want to weight each role. Because if you skip this step, you're not building a portfolio. You're buying random books at a yard sale, and hoping they make a coherent library that you actually like. Section number two, let's start to research and learn about the benchmarks. Once you've met the cast of characters in the sector novel, the next question is, how do you arrange them? Do you give technology a starring role? Does utilities get a cameo appearance? This is where the benchmarks come into play. Benchmarks are essentially the director's cut of the market. And if you're going to build your own fund, you'd be foolish not to at least study them first. Let's take the S&P 500, that venerable giant. Pull up SPY or VOO, two of the main ETFs that track it, on Morningstar, etf.com, or directly on State Street or Vanguard sites. Behind the curtain, you'll see the holdings, sector weights that we went over above, and the turnover. It's a bit like watching The Wizard of Oz. The booming voice and pyrotechnics are impressive, but behind it all, there's a committee in New York City deciding Sears is out and Tesla is in. Here's what you'll find. The S&P is what's called market cap weighted. That means the bigger the company, the bigger the slice of your pie. Apple and Microsoft alone often make up more than 13% of the S&P. This is why owning the market today looks much more like a tech-heavy script than say in 1980, when energy and industrials were the stars. There are other versions of the same story. Look at an equal weighted S&P fund, and suddenly every company has the same billing. Apple gets the same screen time as a regional bank you've never heard of. It's the difference between a Hollywood blockbuster and a community theater production where everyone insists on the same number of lines. Both are technically the S&P, but the experience would be wildly different. Studying benchmarks doesn't just show you who's in the fund. It shows you the logic of how they got there, because indexes don't sit still. The S&P has had roughly 50 to 60 changes in its roster in just the past decade. Some companies get cut, others get promoted. It's a perpetual audition process, ruthless and ongoing. Jane Austen would approve, just as her novels quietly revolve around who gets written into or out of the marriage plot. The S&P thrives on deciding who gets to remain in the eligible pool. Quick side note, this is also why when we reflect on the idea of whether or not the S&P would ever go to zero, it's almost impossible read impossible by its very nature. If companies start to waver, they're going to get cut, and new companies that are solving new problems will replace them. Now, here's the part too many DIY investors overlook when it comes to building their own funds. Tax efficiency. Indexes are extraordinarily good at minimizing taxable events, because they rarely trade, and when they do, they do it with surgical precision. Funds like VOO are far more tax efficient than most active managers would ever be, and certainly more than a do-it-yourselfer who keeps second-guessing their picks. It's not just low fees that make index funds attractive. It's their ability to hold on to gains without triggering taxes year after year, or in many of our cases, day after day. So if you want to mirror a fund, this is where the homework starts. Choose your benchmark. Let's say it's the S&P 500, or maybe you like the Russell 1000 Next, download the holdings, study the sector breakdown, look at historical performance, and ask yourself, could I replicate this with a handful of ETFs or even individual stocks? Could I pick the sectors and weights myself and arrive at something similar? Or am I better off simply admitting the professionals have already done the hard work for me, and it's worth 0.03% per year? There's no wrong answer here. The exercise isn't about creating a perfect clone. It's about understanding how the sausage is made. Think of it like reading the original stage directions for Hamlet. Sure, you could put on your own production in the backyard, complete with homemade swords and a plastic skull from Halloween. Poor Yorick. But even if you never take it to Broadway, the act of reading and staging it teaches you a thing or two about what Shakespeare was probably aiming for. So step two is simple. Study the benchmarks like you'd study a script. Learn the cues. See who gets the spotlight. Notice who gets written out. Because until you understand how the market's great directors are arranging the cast, you won't know how to stage your own version without accidentally writing yourself into a tragedy.