URGENT UPDATE: New research has unveiled significant hidden costs associated with passive investing strategies, raising alarms among investors. A groundbreaking paper by Iro Tasitsiomi, published in June 2025, highlights how index-tracking funds incur substantial trading costs that can greatly exceed their low advertised expense ratios.
This revelation is critical for investors navigating the financial landscape, particularly as the popularity of index funds and systematic strategies continues to surge. With over $538 million in assets under management as of August 25, 2025, firms like Dimensional Fund Advisors and BlackRock are now facing scrutiny over the actual costs investors bear when engaging with these funds.
Tasitsiomi’s research meticulously quantifies the hidden costs incurred during index rebalancing events. These costs arise as passive managers, in a bid to minimize tracking error, often delay trades until the last moments of the rebalancing day. This tactic can lead to substantial liquidity demands on select stocks, opening the door for savvy traders to exploit these situations by providing liquidity at unfavorable prices for passive investors.
In her findings, Tasitsiomi noted that adhering to a strict index reconstitution schedule can lead to trading costs soaring hundreds of basis points above what strategic execution would typically require. For example, funds with expense ratios as low as 0.04% may actually cost investors upwards of 0.4% when hidden trading frictions are considered.
The implications of this research are profound. With ETFs rapidly multiplying, the demand for liquidity around rebalancing days has intensified, causing significant price dislocations. During periods of market volatility or major index changes, trading costs can spike dramatically, affecting overall fund performance.
Additional studies, including one from Marco Sammon and John Shim, confirm that index funds’ reactive trading patterns expose them to adverse selection effects, further exacerbating performance issues. Their research indicated that a simple adjustment—transitioning from quarterly to annual rebalancing—could yield an additional 25 basis points per year for investors.
The concern deepens as the research indicates that the very structure of passive investing might be transferring wealth from ordinary investors to sophisticated market participants, who capitalize on these inefficiencies. The paradox lies in the fact that while passive funds were initially celebrated for their lower costs compared to active management, hidden implementation frictions can significantly erode returns.
Investors are now urged to consider not only the expense ratios but also the total cost of ownership when selecting funds. A growing body of evidence suggests that smaller, more nimble firms may offer better execution and lower implementation costs, allowing investors to capture more of the available market returns.
As the debate surrounding passive investing heats up, key takeaways for investors include the need to scrutinize how funds manage index reconstitution events and whether they employ predictive trading strategies to mitigate hidden costs.
Tasitsiomi’s findings and the ongoing discussions surrounding them underscore the necessity for investors to remain vigilant and informed about the potential pitfalls of seemingly low-cost investment strategies.
In summary, as passive investing continues to evolve, understanding the true costs associated with these strategies is crucial. The call for more sophisticated execution methods and transparency becomes ever more critical, as investors seek to maximize their returns in an increasingly complex market landscape.