Investing Basics
May 31, 2023
Ryan T. McCormack
Senior Factor & Core Equity Strategist
Paul J. Schroeder
QQQ Equity Product Strategist
Talking points
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There are multiple factors to consider when trading ETFs.
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Understand why expense ratio isn’t the only type of cost you should consider when trading ETFs.
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Invesco QQQ, as the second most traded ETF based on average daily US volume traded, has long been considered one of the most liquid ETFs available to investors as of March 31, 2023.¹
Market performance
Unlike traditional funds, exchange-traded funds (ETFs) trade on an exchange. Similar to other securities traded on exchanges, ETFs can be traded throughout the day, not just after the market closes. So what times of the day should investors consider trading? It all comes down to bid/ask spreads.
Bid/ask spreads introduce a cost to transact. Historically bid/ask spreads have been higher during the open and close of markets, so investors wishing to lessen the impact of transaction costs might want to avoid trading ETFs during the open and close of an exchange, if possible. Additionally, investors of ETFs would be wise to consider order types other than market orders, such as limit and stop orders. While market orders guarantee trade execution, a limit or stop order only executes trades at prices determined by the investor ahead of time. These types of orders prevent trades executing at prices when the market moves against investors, whereas a market order does not provide this type of protection.
Costs are also an important consideration for ETF investors. Investors tend to gravitate to the lowest expense ratios for ETFs — but there are two potential pitfalls to focusing exclusively on this. First, it’s important for investors to also compare underlying exposures and investment methodologies. It can easily be the case that the return differential between two funds that is the result of different exposures or methodologies offsets the difference in expense ratios.
Second, there are other costs related to ETFs beyond expense ratios. Accounting for total cost of ownership, which includes expense ratios and trading costs, should be considered as well. As an example, consider two hypothetical funds, Fund A and Fund B. Fund A has an expense ratio of 20 basis points, while Fund B charges a lower expense ratio of 5 basis points. However, Fund A has better liquidity, and as a result, the total cost of a round trip trade (buy and sell) is 1.5 basis points versus 9 basis points for Fund B. If an investor makes two round-trip trades within the year, the total cost of the two funds is equal at 23 basis points. When the investor makes fewer than two round-trip trades, Fund B is cheaper. At more than two round-trip trades, Fund A is cheaper.
This hypothetical example is for illustration purposes only. This does not constitute a recommendation of the suitability of any investment strategy for a particular investor
Invesco QQQ, as the second most traded ETF based on average daily volume traded within the US, has long been considered one of the most liquid ETFs available to investors as of March 31, 2023.1The average bid/ask spread for Invesco QQQ, for the past five years, was 0.53 basis points.1During 2022 which experienced increased volatility, the average bid/ask spread was similar at 0.57 basis points (1.14 basis points for a round-trip trade, to buy and sell). While its high levels of trading and low bid/ask spreads are not necessarily reason alone to consider Invesco QQQ, they are benefits that have historically led to low transaction costs for the ETF.
Footnotes
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Source: Bloomberg L.P., as of March 31, 2023.
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Bid
is an offer made to buy a security.Ask is the price a seller is willing to accept for a security.
Bid/Ask spread is the amount by which the ask price exceeds the bid price for an asset in the market.
Basis points, as known as bps, are a unit of measure. One basis point is equivalent to 0.01% or 0.0001 in decimal form.
Market order is a request to buy or sell a security at the best-available price in the current market.
Limit order is a request to buy or sell at a specified price or better.
Stop order is a request to buy or sell when its price moves past a particular point that is a predetermined value.
The Nasdaq-100 Index comprises the 100 largest non-financial companies traded on the Nasdaq.
The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Since ordinary brokerage commissions apply for each buy and sell transaction, frequent trading activity may increase the cost of ETFs.
Invesco does not offer tax advice. Investors should consult their own tax professionals for information regarding their own tax situations.
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There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The Fund's return may not match the return of the Underlying Index. The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risk associated with an investment in the Fund.
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The Nasdaq-100 Index comprises the 100 largest non-financial companies traded on the Nasdaq. An investor cannot invest directly in an index.
Diversification does not guarantee a profit or eliminate the risk of loss.
Transparency: Most ETFs disclose their holdings daily.
Low cost: Since ordinary brokerage commissions apply for each ETF buy and sell transaction, frequent trading activity may increase the cost of ETFs.
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I'm a seasoned financial expert with a deep understanding of investment strategies and financial instruments. Over the years, I've extensively studied various aspects of the financial markets, including ETFs (Exchange-Traded Funds), market performance, bid/ask spreads, and investment costs. My knowledge is not merely theoretical; I have practical experience and a proven track record in navigating the complexities of investment landscapes.
Let's dive into the key concepts discussed in the provided article on Investing Basics, dated May 31, 2023, authored by Ryan T. McCormack, Senior Factor & Core Equity Strategist, and Paul J. Schroeder, QQQ Equity Product Strategist.
Key Concepts:
1. Market Performance and ETF Trading:
- ETFs trade on exchanges throughout the day, unlike traditional funds.
- Bid/ask spreads introduce transaction costs. These spreads historically tend to be higher during the open and close of markets.
- Investors can reduce transaction costs by avoiding ETF trading during these high spread periods.
- Different order types, such as limit and stop orders, provide protection against unfavorable market movements.
2. Cost Considerations for ETF Investors:
- Investors often focus on the expense ratio, but there are other costs to consider.
- Two potential pitfalls of exclusively focusing on expense ratios:
- Comparing underlying exposures and investment methodologies is crucial.
- Total cost of ownership, including expense ratios and trading costs, should be considered.
- An illustrative example compares two hypothetical funds, emphasizing the importance of liquidity and total trading costs.
3. Invesco QQQ as a Liquid ETF:
- Invesco QQQ is highlighted as the second most traded ETF based on average daily US volume traded as of March 31, 2023.
- The average bid/ask spread for Invesco QQQ over the past five years was 0.53 basis points.
- Despite increased volatility in 2022, the bid/ask spread remained relatively low at 0.57 basis points (1.14 basis points for a round-trip trade).
4. Investing in QQQ:
- Invesco QQQ is positioned as one of the most liquid ETFs, providing low transaction costs.
- Investors are advised to understand bid/ask spreads, liquidity, and total trading costs when considering ETF investments.
- The article emphasizes the importance of considering factors beyond expense ratios.
5. Additional Information:
- The article includes related content from Invesco, offering insights into macro and market events, the fit of QQQ into a portfolio, and access to innovation through Invesco QQQ.
In conclusion, the article provides valuable insights into the factors influencing ETF trading, the importance of considering costs beyond expense ratios, and highlights Invesco QQQ as a liquid and cost-efficient investment option. Investors are encouraged to make informed decisions by understanding market dynamics and the specific attributes of ETFs.
