Understanding Bid-Ask Spread

[Zane]

Hello,

I'm fairly new to investing but have spent the last few months reading various books, blogs and forums to slowly increase my knowledge. I decided to invest in trackers of the FTSE All-World index in my S&S ISA. VWRP has an OCF of 0.22% so I decided to invest in VHVG (Developed Markets) at 0.12% OCF and VFEG (Emerging Markets) at 0.22% OCF which comes to 0.13% total when at a 90:10 split, thereby saving 0.09% per year in fees - clever me!

However I've begun learning about the bid-ask spread on ETFs and I am now wondering if I should have invested in VWRP instead.

Hargreaves Lansdown has the following indicative spread on their website today:
VWRP: 0.06%
VHVG: 0.07%
VFEG: 0.15%

Therefore at a 90:10 ratio I'm getting an indicative spread of 0.078% on buying VHVG + VFEG. Compared to VWRP, the spread difference is 0.018%.

I decided to workout how long it would take to reach a break even point between the lower spread of VWRP and the lower fees of VHVG + VFEG using an example of £100k invested as a lump sum.

Using the spread difference of 0.018% the £100k would drop to £98,200. If I then compound the £98,200 at 1.0009% per year (the saving in fund fees) it takes 21 years to catch up to £100k! Assuming the spreads are similar in 21 years I'd lose out again during the selling process so to truly break even I'd actually have to hold the funds for 42 years!!

Am I correct? Have I correctly interpreted how the bid-ask spread works?

I realise that in the grand scheme of things this small % difference won't make a significant impact on my life and that by buying earlier or later in a given day the price could move by much more than the spread. However I thought it would be useful to work through this example to check my understanding.

Additionally, I looked at the new FWRG ETF which also tracks the FTSE All-World index. It has an OCF of 0.15% and an indicative spread of 0.22% so would be even worse than VHVG + VFEG.


Thanks,
Zane

[mc2fool]

Using the spread difference of 0.018% the £100k would drop to £98,200.

0.018% of £100,000 is £18, not £1,800.

0/10. See me.

Welcome to the Lemon Fool!

[Urbandreamer]

Using the spread difference of 0.018% the £100k would drop to £98,200. If I then compound the £98,200 at 1.0009% per year (the saving in fund fees) it takes 21 years to catch up to £100k! Assuming the spreads are similar in 21 years I'd lose out again during the selling process so to truly break even I'd actually have to hold the funds for 42 years!!

Am I correct? Have I correctly interpreted how the bid-ask spread works?

Well your math is wrong. Also the spread is only one component to think about. Tracking error can be far larger.
However ignoring those things, and the difference between active and passive investment, you have the gist.

FWIW, many who invest in gold are happy to accept 5% or above spreads.

As you can tell, I think that your are concentrating upon the less important aspects of investing. However that's your business.

[EthicsGradient]

Indicative spreads are also not always reliable when markets are closed, eg on a Sunday. Better to check when the market is trading - and really, they're still only "indicative" rather than "true" then - you need to get a quote for buying and selling in quick succession to actually see the spread.

[monabri]

Using the spread difference of 0.018% the £100k would drop to £98,200.

0.018% of £100,000 is £18, not £1,800.

0/10. See me.

Welcome to the Lemon Fool!

Well that's £1782 saved already!

[88V8]

Indicative spreads are also not always reliable when markets are closed, eg on a Sunday. Better to check when the market is trading - and really, they're still only "indicative" rather than "true" then - you need to get a quote for buying and selling in quick succession to actually see the spread.

Yes, even in illiquid stocks, one can usually get a price within the apparent spread.

V8

[Lootman]

Indicative spreads are also not always reliable when markets are closed, eg on a Sunday. Better to check when the market is trading - and really, they're still only "indicative" rather than "true" then - you need to get a quote for buying and selling in quick succession to actually see the spread.

Yes, even in illiquid stocks, one can usually get a price within the apparent spread.

And you can always submit a limit order, so you only pay a price that you like.

[Zane]

How embarrassing that I got my maths wrong! I got a red face while reading the replies.

Thanks to everyone that has given replies.

[vand]

Every instrucment that trades on an exchange is subject to a bid/ask spread - it's how real time price discovery works. However, as already said, if you're a long term investor it really shouldn't be anything more than a tiny rounding error. It's the wrong thing to bear attention on unless you're in some illiquid markets.

[GeoffF100]

In addition to what has already been said, I should add that ETFs can also trade at a discount or premium to Net Asset Value, which is reported only once a day. You do not necessarily avoid transaction costs by using OEICs ether. They use swing pricing to recover the cost of creating and redeeming shares, which is completely opaque to the investor. There are costs, and they are not always visible, but if you invest in equities you have to accept the luck of the draw.