Some good reads from around the web.

A couple of decades ago, a friend of mine wrote a short semi-spoof mathematical proof on relationships and sex.

I don’t remember the specifics – something about numbers of dates versus the chances six months later of certain steamy sexual acts – but for five minutes it was very popular on the Internet (which meant it got emailed around a lot: that was the Internet two decades ago!)

We’ve come a long way since then. Today my friend’s proof would be spread by Twitter and Facebook, and, equally, nobody would bat an eyelid. Applying esoteric academic theory to love and marriage has gone from an undergraduate joke to mainstream respectability.

Personally, I remain very partial to explanations of why I am so much more attractive in my 30s to women than when I was 21 (it’s certainly not my sports car!) or why so few men try to chat up the one ‘Perfect 10‘ in a bar.

Such theories are full of holes, of course, and desperately short of romance. Yet like all economic theory, pretending the world is populated by Vulcans making purely rational choices (rather than by us nutters who really do inhabit it) can yield interesting insights, and make you feel less frustrated about your partner’s obviously compromised mental state, as this article from Salon explains:

Imagine, for example, a woman who has hooked up with a guy and has to weigh the cost and benefit of either staying the night or sneaking out to get a better night’s sleep in her own bed.

Either way, it’s all about resources and trade-offs,” says Paula Szuchman, author of the upcoming Spousonomics.

“If you start thinking instead like, what will he think if I leave, how will I be perceived if I don’t leave, etc., etc., you muddy the waters. If you take out the static and focus on the actual trade-off — sleep or no sleep — you’ll make the right decision. In theory.”

So take heart, mon petit: There’s an equation out there somewhere to mend it!

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Investing involves so many costs, fees and charges that sometimes I think my assets stand about as much chance as a stick of pepperami in a piranha tank.

The bid-offer spread is yet another oft-overlooked cost that will nibble away at your returns unless you take evasive action. And, as a passive investor, one thing that I’m active about is costs.

The bid-offer spread (or bid-ask spread in the US) afflicts passive investors who use Exchange Traded Funds (ETFs) and to a lesser extent Unit Trusts. The spread is the difference in the buy and sell price offered for a security at any given time.

Just like when you convert foreign currency at a Bureau de Change, it always costs a little more to buy than you can get when you sell.

An example will help explain:

Consider the FSTE Magic Upside Generator ETF (Ticker: MUG).

The bid price (i.e. the highest price I can sell for) = 99p

The offer price (i.e. the lowest price at which I can buy) = 101p

The bid-offer spread = 2p per share (or 1.98%)

The bid-offer spread therefore costs me 1.98% from the moment I buy into the MUG ETF, on top of any other trading fees like broker’s commissions.

Once I’ve bought, I need the bid price to rise to 101p before I break even on the deal (ignoring all other costs).

Tighter is better

Clearly, the tighter the bid-offer spread, the better off you are. But unfortunately, there’s no such thing as a ‘normal’ or ‘acceptable’ bid-offer spread.

The spread reflects the nature of the fund’s underlying securities like a bulge beneath your t-shirt reflects an underlying fondness for pies.

Heavily traded, liquid securities have lower bid-offer spreads because it’s easier to match up the buyers and sellers of such popular fare, which lowers the middleman’s transaction costs ¹. If your desired ETF tracks the FTSE 100, the spread can be as little as a few hundredths of a percent.

In contrast emerging market funds generally have wider spreads, reflecting the higher cost of trading in more illiquid shares.

Some ETFs carry huge bid-offer spreads of over 3% – a massive cost clobbering to take.

Where to find the bid-offer spread

Bid-offer prices can be found on the website of the ETF provider, via your online broker, or through the stock exchange itself.

To give you a taste of what to expect, here’s a quick sample of bid-offer spreads, using January 28 closing prices for some UK-listed ETFs:

ETF	Bid (pence)	Offer (pence)	Spread (%)
iShares FTSE 100	587.2	587.6	0.07
dbx Emerging Markets	2,605.54	2,613.3	0.3
CS MSCI UK Small Cap	9,549	9,860	3.15

As you’d expect, the highly liquid, large cap equities of the FTSE 100 show a miniscule spread. But the gap widens to a not insubstantial 0.3% once we’re into emerging markets territory.

Then there’s our controversial old friend CS MSCI UK Small Cap, which is about as liquid as the surface of Mars. Its spread of 3% brings to mind the hideous initial charges of expensive mutual funds!

Five ways to fight the spread

1. Be broadminded

The best way to avoid gaping bid-offer spreads is to invest in broad market indexes that track highly liquid securities.

2. Consider the index

Always check what index your potential ETF purchase tracks.

If it’s mimicking a liquid index like the S&P 500 or the DJ Euro STOXX 50 then you’ll have very little spread to worry about.  But if your index is slicing and dicing a tiny portion of the market – solar energy, or ethical tobacconists, perhaps – then trade in the underlying securities is likely to be less brisk, and bid-offer spreads will widen.

And don’t be lulled into a false sense of security if you’re looking at a niche sector that’s flavour of the month. It could be liquid now as everyone piles in but freeze up later when everyone’s bolting for the exit.

3. Watch and wait

It’s a good idea to watch the bid-offer spread of your target ETF for a few days before you buy, so you can get a feel for how wide it should be. (This is even more true if you turn to the darkside buy individual company shares).

4. Numbers speak volumes

If you’re comparing similar funds, then use the following indicators as a tie-breaker:

• Assets under management
• Daily trading volume
• Number of market makers

You’re looking for higher numbers in all these categories when comparing ETFs. They’re all suggestive of a more liquid fund and hence a tighter bid-offer spread. (Although it’s admittedly a bit like using the Met Office’s 5-day weather forecast to decide whether you should wear waterproof trousers next Tuesday).

5. Not so fast, cowboy

Trade less. A one-off cost of 0.3% is easy to take if you’re investing for the long-term, whereas the bid-offer spread matters far more if you’re tempted to trade frequently. If you buy and hold (or buy and sell-only-rarely) then it’s much less of an issue.

Bonus tip: Use limit orders

You can avoid nasty surprises caused by sudden price movements and yawning bid-offer spreads by using limit orders when buying and selling less liquid ETFs.

Here you place a limit order with your broker, specifically stating your maximum buying price, or your minimum selling price. A limit order puts you in control. If the offer price exceeds your limit then you won’t buy.

Once you’ve monitored the ETF’s price for a few days then you’ll have a good idea at what level you should set your limit order.

I personally don’t use limit orders because I buy my ETFs using a regular investment scheme. The broker bundles up my order along with countless others and buys on a pre-determined day. I lose control over the bid-offer spread but gain by slashing the cost of the broker’s commission.

Take it steady,

The Accumulator

1. Technically, it also reduces the risk to the market maker of making a market in those securities, by risking being lumbered with the baby![↩]

Some good reads from around the web.

You can’t keep a bad idea down in the financial services industry – like Hindu vetala, the same ruses, obfuscations, and scams keep resurrecting in new forms to haunt us.

Well, that’s if the service providers in question have any sense of irony. Clearly that’s lacking at The Royal Bank of Scotland, who’ve decided to resurrect a controversial idea in the form of… the same controversial idea.

Barely a fortnight ago, Barclays was fined £7 million for investment advice failings, which basically amounted to calling funds ‘cautious’ and ‘balanced’, which the average consumer hears as ‘safe’ and ‘secure’.

So I was pretty surprised to get a press release from RBS that kicked off:

Today, the Royal Bank of Scotland will launch a major push into the retail fund management sector with the launch of two new funds (Cautious Managed and Balanced Managed) that have competitive charges, and aim to manage volatility to below market averages.

*Splutter!* What gives? Had RBS already spent so much on paperwork and logos for the new funds that it decided a fine of £7 million was a small risk to take?

Then we get to the money shot:

The Cautious and Balanced Managed sectors are among the most popular with IFAs and retail investors.

Ah, now I get it!

Moving on, RBS explains its strategy with the new products as follows:

The bank will be using a unique combination of strategies around diversification, trend analysis and volatility control to deliver its new propositions.

Here the news is a little better. Regular readers may recall me moaning about structured products in the past. I was happy (and not a bit surprised) to see that these funds simply offer regularly rebalanced exposure to the standard asset classes, with no derivatives linked to the value of the FTSE in 2015 or what have you.

But as the FT points out, the cautious fund could hold up to 51% of its money in equities, while the balanced fund could hold up to 81%. These may fit the current guidelines for those labels, but they don’t seem wise after the Barclay’s ruling.

Finally, the 1% annual charge isn’t the worst offender in the world, but all that rebalancing could result in a higher and somewhat hidden Total Expense Ratio.

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