If you buy and sell an exchange-traded fund, you'll incur more than a trading commission. As with stocks, there's a difference between what a market maker will charge an ETF buyer and what that same dealer will pay a seller. The difference is the "bid-ask spread," and for investors, the smaller the spread, the lower the cost. As a rule, when an ETF sees little trading activity, bid-ask spreads can get wide.
Once you know the bid-ask spread, you need to compare it to the ETF price. That gives you the bid-ask ratio, available at xtf.com. In August the average ratio on ETFs was 0.02% to 0.03% of the share price, or 2¢ to 3¢ on a $100 share. On ETFs that don't see a lot of trading activity, spreads and ratios can be wider, which eats into returns.
*This ratio is the bid-ask spread as a percentage of an ETF's price, calculated throughout the day and averaged
**These ETFs track different small-cap indexes. Table data are from Jan. 1 to Aug. 31, or since inception
Data: XTF Global Asset Management
To get a rough idea of an ETF's total cost, multiply the bid-ask ratio by the number of times you expect to trade the ETF over a year (a purchase and sale count as one trade). Then add the expense ratio (the fees that pay the fund's overhead). And don't forget commissions. Among similar ETFs, cost depends on how much you trade. Look at the iShares Russell 2000 and the Vanguard Small-Cap ETFs. The Vanguard fund has an expense ratio of 0.10%—half the iShares' 0.20%. But the Vanguard fund's average bid-ask ratio is 0.07%, vs. the iShares' 0.01%. If you trade once a year, Vanguard is the lower-cost choice—the 0.10% expense ratio and the 0.07% bid-ask ratio combine for a 0.17% total cost. Trade it twice, and the Vanguard goes to 0.24%, vs. 0.22% for the iShares.
Copyright 2007, by The McGraw-Hill Companies Inc. All rights reserved.
