Bid/Ask spreads

[Dr Oli]

Can anyone sum up how much a bid/ask spread actually matters when investing in ETF's?

Like many of you I've got a mix of mutual funds and ETFs in my tax deferred accounts, primarily because they are in a self-directed Schwab platform and so any non-Schwab mutual fund costs me almost $80 to purchase. For this reason, most of my Vanguard holdings within retirement accounts are their ETF offerings (a little under $9 to purchase)...and recently I've added some Schwab ETFs which cost a very nice 0$.

But usually I simply place a "market" order to buy any ETFs, and often wonder whether in my preference to keep transaction fees low I am giving up something equivalent to at least $9 (hopefully not close to $80!!) to get in to these ETF products. Is this true? And it appears that for some ETFs the bid/ask spread is larger than others. Does this matter much? I only have index ETFs in my portfolio if that makes a difference, but my understanding is that most ETFs are index products.

I guess I'm just not really understanding how this bid/ask spread really works since I also don't own individual stocks and so an unfamiliar with their purchase as well.

[Antares]

You are keeping these in retirement accounts. The bid/ask spread will be irrelevant over more than a very short period of time. In ten or thirty years, the blip of the bid/ask spread will not even be noticeable. Don't worry about it.

if you are especially nervous about placing a market order, you could spend the time placing a limit order, or place the order while the market is open. I usually do neither of these, but if you'll sleep better, the option is yours.

[Dr Oli]

Understood. But I guess the blip of a $9 commission vs. an $80 commission would also virtually disappear after these long time periods... if it's really that minuscule I won't worry about it. Does anyone know what the dollar amount of a spread amounts to for a given amount invested?

Really, paying an $80 up front commission seems no different than a front end load. But this still amounts to a decent amount with each contribution if you're contributing amounts less than say $10,000 into such a fund at a time...

[Lithium]

A bid/ask spread is a one-time transaction cost.  They can vary from day to day and within the day, and it is worth paying attention to it and calculating how much it is actually costing you.  It is not that difficult.  Schwab will show you what the spread is, and you can multiply the spread by the number of shares to figure out the total cost of that transaction.  It is really only a big deal if you are making large purchases.

If I am going to buy an ETF, the bid/ask spread seldom affects which ETF I choose, since expense ratio and overall quality of the fund in the long run matter a lot more than one-time transaction costs for a fund that you hold long term.  But when I decide to buy something, I take a look at the bid/ask spread, and compare it to what it usually runs (you can find this on etf.com).  If the bid/ask spread is much higher than usual, I will hold off on purchasing for a few hours and check again later.

In your case, if you buy an ETF with a spread of 10 cents, you would have to buy 710 shares of that ETF before the spread would cost you $71, and then $71 + $9 would mean that the transaction costs would be the same as the $80 it would cost you to buy the mutual fund.  So if you were going to buy more than 710 shares, the bid/ask spread would have to be less than 10 cents for it to be cheaper to buy than the mutual fund, and if you are buying fewer than 710 shares, it would have to be more than 10 cents for the mutual fund to be cheaper to buy.  This is all assuming that the expense ratios for the mutual fund and ETF are the same.  In the long run, superior returns due to lower costs should make up the difference in a one-time purchasing cost.

[Zaphod]

I guess Im not understanding. How does the bid ask spread impact anything other than on a nanosecond level? Fwiw, I almost never do a market order, some hft or someone paying attention could put in a crap bid and hurt you (unlikely in liquid instruments but still). On large etfs the bid/ask is usually a penny or few. It doesnt matter at all.

Schwab has some of the cheapest ETFs in the industry (their large market caps are cheaper than VG), and they are free to trade on their platform along with the most commission free ETFs...so why take the extra effort to get basically the exact same fund from a different broker?

[Zaphod]

Also, since I see everyone talking about commissions every so often, Merrill Edge has a nice platform with access to any of these companies products along with their own and you only need 100k to get unlimited free trading. My trades usually run me a few cents for the SEC fee only.

[The White Coat Investor]

A bid-ask spread is a cost, just like anything else such as a commission, a mutual fund ER, or a tax bill from an inefficient investment. You do what you can to minimize them. The way to minimize bid-ask spreads is to invest in more liquid securities and to do as few transactions as possible.

But if the bid-ask spread is 2 cents on a share that is $100, that's a round trip cost of 4 cents, or 0.04%.If the bid-ask spread is 20 cents, that's a cost of 0.4%, which is obviously a little more significant, but spread over many years is still pretty low.

[Dr Oli]

I just checked my desired purchase (TD ameritrade account this time) at 7:00 central and for a very common ETF (VT), the bid ask spread was....$1.10!! Seriously. Now I'm assuming this is purely a result of checking after market hours, as I see on website ETF.com that the normal spread for this ETF is only 0.01.

This must correct itself at the exact moment the market opens?

I'm not home during market hours and prefer not to use shared computers, or even personal work computers, to check my accounts while at work. Can I realistically place a market order now or is there actually a risk that the spread really will open at over $1.00?

 

 

[Zaphod]

Dr Oli wrote:

I just checked my desired purchase (TD ameritrade account this time) at 7:00 central and for a very common ETF (VT), the bid ask spread was….$1.10!! Seriously. Now I’m assuming this is purely a result of checking after market hours, as I see on website ETF.com that the normal spread for this ETF is only 0.01.

This must correct itself at the exact moment the market opens?

I’m not home during market hours and prefer not to use shared computers, or even personal work computers, to check my accounts while at work. Can I realistically place a market order now or is there actually a risk that the spread really will open at over $1.00?

 

 

Click to expand...

No it doesnt, at the open things arent actually in full swing either and not all things are even trading, and just like after or pre-market hours there is less liquidity (less buyers and sellers) and you can definitely get a bad fill. If you're uncomfortable trading at work or off your phone, just set a limit order at a price thats near whatever its been around daily or that you'd be happy to own at and wait for it to come to you. You can set your order for one day or GTC, "good til cancelled" which timing depends on your broker, mine is 30 days.

I would not set a market order unless its at a price that you happen to think is great and are right there at the time. Set a limit order even after hours and your broker will notify it will go into effect the next trading day (unless you're specifically on an extended hours trading window).

[VagabondMD]

When the bid-ask spread is large, it is usually a sign of a thinly traded ETF, and I would prefer to buy those that are more liquid.

[WallStreetPhysician]

Dr Oli wrote:

I just checked my desired purchase (TD ameritrade account this time) at 7:00 central and for a very common ETF (VT), the bid ask spread was….$1.10!! Seriously. Now I’m assuming this is purely a result of checking after market hours, as I see on website ETF.com that the normal spread for this ETF is only 0.01.

This must correct itself at the exact moment the market opens?

I’m not home during market hours and prefer not to use shared computers, or even personal work computers, to check my accounts while at work. Can I realistically place a market order now or is there actually a risk that the spread really will open at over $1.00?

 

 

Click to expand...

If you only can place trades outside of regular market hours, then use a limit order.  In my opinion, limit orders do not actually reduce bid-ask spread compared to market orders, because your limit order does not typically fill until your bid is equal to the market ask price.  In any event, for long-term investors who rarely trade, the bid-ask spread will not matter in the long-term. However, if you are a trader, the bid-ask spread can get expensive quickly and is one of the reasons why I discourage physicians from trading (http://www.wallstreetphysician.com/8-reasons-should-not-trade/).

[The White Coat Investor]

Dr Oli wrote:

I just checked my desired purchase (TD ameritrade account this time) at 7:00 central and for a very common ETF (VT), the bid ask spread was….$1.10!! Seriously. Now I’m assuming this is purely a result of checking after market hours, as I see on website ETF.com that the normal spread for this ETF is only 0.01.

This must correct itself at the exact moment the market opens?

I’m not home during market hours and prefer not to use shared computers, or even personal work computers, to check my accounts while at work. Can I realistically place a market order now or is there actually a risk that the spread really will open at over $1.00?

 

 

Click to expand...

I don't put in trade orders for ETFs after hours. Mutual funds, fine. But not anything actually traded on the market. One downside of ETFs to me.

[Scott at MD Financial Services]

The reason why there can be a big spread is the 'market makers' have to maintain a buy and a sell for a marketable security they make a market in.  When the market is closed or they are away they put a ridiculous spread in there that if the market has a major swing or someone makes a mistake they are happy to sell into that or buy what someone is dumping.  That is how the markets stay 'liquid' is the 'market makers' always have a buy and sell offer out....regardless of how good it is.