I recently had a discussion with ChatGPT about the mechanics of ETF’s and how the structure creates a self-optimizing system. Most generic indexed ETF’s such as QQQ or SPY are rebalanced on a quarterly basis, meaning the weighting of the individual constituent stocks are rebalanced according to the market cap each quarter. Individual components are added or subtracted when they meet or don’t meet certain thresholds. 36% of the constituents of SPY turnover every 10 years. 10% of the QQQ constituents turnover every year. in the Chat below ChatGPT does a good job of discussing how this works and how it is beneficial to the average investor.
I posed this simple query:
Due to rebalancing & reconstituting these generic ETF’s generate solid performance. The self reinforcing system does chase momentum creating volatility, but over time they are a great vehicle for a set it and forget it portfolio. An investor in these vehicles needs very little knowledge about stocks or their fundamentals.
You’re exactly right — and you’ve just captured one of the core structural advantages of broad, rules-based index ETFs like SPY, VOO, QQQ, and even SCHG/SCHD/OMFL:
They create a self-reinforcing engine that rewards winners, removes losers, and compounds performance without requiring the investor to have stock-picking skill.
Let me break down why these ETFs work so well over long horizons.
✅ Why Rebalancing & Reconstitution Make These ETFs So Effective
1. Winners get bigger weight → losers get kicked out
Indexes like the S&P 500 and Nasdaq-100 are fundamentally survival-of-the-fittest machines:
- Rising companies (by market cap, earnings, liquidity criteria) get added
- Stagnant or shrinking companies get removed
You end up owning more of the winners automatically, without emotional decision-making.
This is one reason passive funds beat most active managers — the index won’t “fall in love” with a losing position the way a human might.
✅ 2. Systemic momentum chasing — but in a good way
Market-cap-weighted indexes are momentum-biased:
- If a stock is rising, its weight increases
- Rising sectors (like tech in the 2010s/2020s) dominate the index
- Declining sectors shrink or disappear
This does create volatility, but it also captures powerful long-term secular trends.
It also explains why the S&P 500 rarely stays stagnant for long — it continuously refreshes into whichever part of the economy is growing.
✅ 3. Rebalancing creates forced “buy low, sell high” behavior
Even though the weighting is market-cap-based, the quarterly (SPY) or annual + quarterly (QQQ) rebalancing:
- Trims positions that have become too large
- Adds to positions that have lagged but remain eligible
- Keeps the index aligned with the real economy
This mechanical discipline reduces tail risk and prevents extreme concentration (unless the methodology allows it, like in the Nasdaq-100).
✅ 4. Turnover removes weak businesses before they become disasters
Think about all the dying companies that used to be in major indexes:
- Eastman Kodak
- Sears
- K-Mart
- Gateway
- Sun Microsystems
- Yahoo
- BlackBerry
- GE (eventually removed)
You never had to decide when to sell them — the index did it for you, unemotionally, based strictly on rules.
✅ 5. “Set it and forget it” works because the ETF handles the heavy lifting
For most investors:
✔ No financial statements to read
✔ No forecasting earnings
✔ No monitoring management decisions
✔ No worrying about individual blowups
✔ No timing decisions
The ETF automatically:
- Updates its winners
- Removes losers
- Rebalances weights
- Tracks the economic frontier
- Provides professional diversification
- Maintains sector balance
- Avoids emotional bias
Your only job?
Keep contributing and don’t panic sell.
✅ 6. Long-term data supports your point
Over 20–30–40 year periods:
- Indexes outperform the vast majority of active managers
- Momentum exposure enhances returns
- Forced trimming reduces downside risk
- Automatic replacement of losers improves survivorship bias
- Low fees amplify compounding
This is why Buffett famously said:
“Most investors are better off owning a low-cost S&P 500 index fund.”
📌 Final Thought
You’re absolutely on target: these ETFs are mechanical, disciplined, and self-optimizing products that exploit:
- momentum
- diversification
- market self-selection
- rebalancing effects
- economic growth
…and do it all passively.
For 95% of investors, a portfolio of:
- S&P 500 (VOO, SPY)
- Nasdaq-100 (QQQ)
- Large-cap growth (SCHG)
- Dividends (SCHD)
- Total market (VTI)
…is the cleanest, safest, most efficient way to build wealth.