IFB125: Using the Bid-Ask Spread to Buy Zero Commission Stocks (over ETFs)

Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave:                                    00:35                     All right folks, we’ll welcome to the Investing for Beginners podcast episode 125 tonight. Andrew and I are going to continue our ongoing discussion about the no commission news that hit the stock market last week, and we had some other additional thoughts that we wanted to share with you about a couple of different topics. So the first one we’re going to talk about is something that I broached with Andrew earlier this week, and we’ve talked a little bit about it off air and we thought this would be something that might be of interest to you guys and see if it was something that might help you with your investing. So the thought that I had was, how is this going to affect ETFs? And the reason why I thought that was because before when you would go on ally, for example, and buy an ETF, let’s say a VOO, which is an ETF that tracks the top of P E an S and P 500 has got 516 stocks, I believe.

Dave:                                    01:38                     So it tracks the majority of the S and P plus a few extras. So what’s to stop you from doing something a little bit different? So in the past, when you buy this particular ETF on ally, you would pay four 95 for your trade like everybody did for any other stock. And then, during the year, the ETF would also charge you a fee to manage and operate the ETF for you. Now in this particular case, it’s a 0.3, so it’s quite small, but it’s; still, it’s money that is taken from your returns at the end of the year. And so my thought was, is now that you don’t have to pay that four 95, why would you pay for the commission on not the commission, but why would you pay the management fee on the ETF? And my thinking was is that you look at, when you look at an ETF, you can see a breakdown of what it is that they are holding in that ETF.

Dave:                                    02:43                     And in this particular case they’re holding the top 10 stocks that are in their particular portfolio are some pretty big hitters. It was, let’s see here, we got Microsoft, Apple, Amazon, Facebook, Berkshire Hathaway, JP Morgan, alphabet class a and C stocks, Johnson and Johnson and Procter and gamble. And it tells you what the weighting of all those are. And that’s 21% of the whole portfolio that they hold in this ETF. And I thought to myself, well, why wouldn’t I buy those stocks individually? Cause now I don’t have to pay for them. It doesn’t cost me to buy all 10 of those stocks other than obviously buying the shares and spending the money on the shares. But if you’re looking to build a portfolio, for example, what’s to stop you from just looking at this and buying all 10 of those stocks and it costs you nothing to manage it, and it costs you nothing to invest in them initially.

Dave:                                    03:42                     So the four 95 that you would pay for these ten stocks, that 50 bucks that you would, you know, have to shell out for each purchase would now you could use that money towards your investments. And I guess I’m wondering how in the long run this is going to affect ETF’s, index stocks as well as mutual funds because now you can go on your brokerage account, which whoever it may be and not have to pay to purchase these, but you’re still going to have management fees. And in some cases they could be higher. And I guess my thought is if you are of a bent, like Andrew and I are and want to buy individual stocks, why would you buy an ETF when you could do something like this? I mean there are their advantages obviously, but I guess my thought was is that this is a really great will cost way to invest in some pretty darn good companies and save yourself some money, which of course over the course of, you know, a very long time would save you money that you could use for your retirement or buying a house or paying off a medical bill or whatever it may be.

Dave:                                    04:57                     Those are all advantages that you could take advantage of yourself. So now that I’ve spewed all my info, Andrew, I’m curious what your thoughts are on this

Andrew:                              05:09                     As an individual investor too, you can kind of build your own, modify the index. So maybe you are pretty high on most of the S and P, but maybe let’s say, I don’t know, you look at a stock like Amazon or Netflix, and you think, I don’t like that. These stocks, yeah, they’re great businesses, but their valuations are sky-high. The price to sales is, I’m higher than I would like. And so maybe I’m building an index. And excluding those, I think it was less available to the average investor. I think somebody where a four 95 commission was limiting. Now it’s going to pray the type of opportunities like that. And particularly with ETFs. You know, if we go back to what an expense ratio is like you said, David’s what the ETF company is charging you for them to manage your assets for total stock, total stock market index fund like VOO or there’s SPY, another one.

Andrew:                              06:23                     These tend to have low expense ratios, and that’s why investors like them so much. But when you start to get to a lot of the other types of ETFs, especially as, as they get specialized you can find an ETF for almost anything these days. And now you see these ETFs that are levered, which makes it even more interesting. But you know, any typical type of ETF, like let’s say it’s a wheat stock ETF, the expense ratios will tend to be much higher than what you’ll see with like a broad index tracking ETF. And so now when you’re talking about an expense ratio of let’s say 1% versus point, however many percents now that can start to eat in and then you have to consider that that’s not just a one time thing, but if it’s an expense ratio, it’s getting taken out every year.

Andrew:                              07:18                     Now you have this opera, this, this kind of give and take between. If I’m knowledgeable enough that I understand whether an expense ratio is, I understand how to find what holdings at a particular ETF is, then what’s one more step to just buying those stocks outright? As you said, Dave, I think it’s a lot more reasonable now. Now, the biggest thing, I guess the biggest hurdle behind that is that depending on the stock, some of them could trade much, much higher. So an example would be like Berkshire B use it or an Amazon I think is in the thousands and Netflix is in the several hundred. So depending on how diversify of a portfolio you’re building, that could become an issue. But you know if stocks do stock splits to kind of accommodate that, it would be interesting to watch, you know, if, if more people start to, and I don’t even know how you would measure it, but more people building their own ETFs or having these little like I own one share of this, one share of that one share of that. If you see a lot of that if the stocks will accommodate by splitting their shares to allow more people to do that, who knows? I mean, we’re, we’re just at the birth of this.

Dave:                                    08:45                     .Yeah, very true. I mean, that’s, I think that’s one of the things that’s kind of interesting about it. It’s been a topic on a lot of the podcasts that I’ve been listening to an MEB Faber was talking about it the other day. And I know that two by two by, as Carlisle was talking about the other day. So, you know, I think this is going to start making the rounds a lot more as you go along. And I think people are going to be talking about some of these things that Andrew and I are talking about today, about how this is going to affect individual investors. The large, the large institutions that are investing. This isn’t gonna be a big factor for them, but for us, you know, average Joe, smaller guy this is going to have a huge impact on our investment in our choices and what we can do. And I think reduction in fees I think is going to continue. The professionals that do this for a living, they got to figure out a way to make money.

Dave:                                    09:44                     And I certainly don’t want to take away, you know, a livelihood from people, but by the same token, they’re going to people are going to start to figure out a way to do these types of transactions or investments that are going to be lower costs for people. Because the kind of the unhidden or untalked about aspect of investing has always been, you know, the costs that you pay to invest as well as the tax implications. And so as people get more and more involved in this, I think there’s going to be less and fewer fees being charged for people because people are going to be more aware of this and it’s going to be a lot more discussion about it. And I think people are going to start asking those questions, well, why am I paying you to do this when I could do this on my own?

Dave:                                    10:39                     Or there are other ways that people can do it on their own. And there’s such a huge advantage for the investor now that it puts us more in a position of control than it did previous to all this. And this, this has been going for a while now, this discussion on, that’s really why ETFs were created was kind of a backlash against mutual funds because of the how they have managed and the cost that they were charging people to manage those funds. There was, you know, I think that’s why ETFs were, was created, was to allow people to do this. And something that I, I also think with Robin hood, really started kind of the tradition. Tradition is not the right word for it. It started the movement towards the younger people being able to invest and not having to spend a lot of money. It was more of a, I guess I felt like a video game aspect to it, and now with all of the brokerages doing this, going that route, I think there’s going to be more interest in investing

Andrew:                              11:54                     And I think that drops the shields if you will, and it makes it more open to everybody as opposed to before there was a speed bump or a barrier to getting involved in it. What are your thoughts on that? Yeah, I mean 100% I think it can be kind of discouraging to look at a stock and say, well, I’m getting a 10 cent dividend. Yeah, I paid four 95 for this stock with a transaction fee. Right, right. Well now that’s, that’s eliminated, and then you can move in and out of the stocks a lot easier. I think it opens up a lot of opportunities, but I think it also opens up a lot of risks because I think the temptation, Apple is now dropping even lower to invite all sorts of other types of strategies which might be counterproductive. Things like trying to day trade in and out.

Andrew:                              12:54                     Like if you’re trying to capture 1 cent here, 2 cents from there, from training in and out of stocks, that’s where you can get into trouble. But you know, I guess to your point, yeah, it’s, it can also help a lot of people. I think our podcasts in general, we probably contribute to empowering people and having them less pay the professionals and then the other way around. Yes. I think some of the other things that people need to consider if they are going to manage their money more on the active level. It’s interesting. I feel like we kind of sit somewhere in the middle of between being completely passive and being active, and it’s kind of like this Teeter toddler, and there’s a fine balance to it. And so you need to keep in mind, one of the hurdles to being an active trailer was the fact that it’s really, it was really hard to make a profit if you had a small amount of capital because the transaction fees were eating away at your returns.

Andrew:                              14:11                     And so now that that’s gone, you have more potential to realize that those gains and not have to have $10,000, you know, to, to make smaller trades more profitable at the same time. There’s a lot of, you know, and that I think a lot people would default to more passive investing because as you look into active trading and you’re like, well, that’s a huge hurdle and I can’t do anything about that. Now that’s kind of out of the way a little bit, but you have to consider too that there’s also taxes and the fact that it’s very, very hard, if not impossible to time the market. You can go ahead and try for yourself. And let me know how that goes. Yeah, but you know, I think there are some things through this process that can kind of help somebody who’s maybe maintaining that balance in a good way, where maybe you see an opportunity to capture some of, I don’t know.

Andrew:                              15:17                     I might be kind of way out in the left-field, but I think it’s definitely promoting more active trading I think. I think there will be a lot more just as time goes on and, and more of the stuff goes online, right? Like what was it 20 years ago? If you wanted to get a 10 K document, you have had to maybe as longer than 20 years, let’s say 30 years ago you’d have had to call into investor relations, have it mailed to you. You will have to pay like five bucks or whatever it was. Now you can look it up instantly, any 10 K and same with the ETF thing. You can look up the holdings as of today. You can look it up without having to pay for anything. So definitely, the knowledge advantages are to the average investor now.

Andrew:                              16:03                     And so there are some parts of that I think as people are diving in and if you’re somebody who’s trying to be more kind of action than Hey, I’m just going to buy an index and forget about it, there are some things that you need to consider. And I think first and foremost obviously that everything we’ve talked about in the podcast up to now, the longterm investing, the validity behind that the logic and wisdom behind that. And the reason why it works, it goes beyond just transaction fees. It’s also to the point that you’re not trying to time the market and on top of like tax savings and all of that. However, you know, if you do try, like I’ve taken some money, I have a little fun account, and I’m trading in and out of stocks to see how that goes.

Andrew:                              16:57                     I think there’s, there are certain things you need to keep in mind as you’re managing a brokerage account. So one of the things, and we’ve never, I don’t know why we’ve never talked about this on the podcast before, but one of the things to understand about when you are buying stocks well if you’re buying a stock, you’re buying it from somebody else. If you’re selling a stock, you’re selling it to somebody else. And so kind of similar to, I wouldn’t say it’s like similar to an auction because an auction kind of goes one-sided, but I don’t know, let’s say you’re at like a garage sale, right? And there’s the price that’s on there. And then as some of the who’s maybe haggling, you’re saying, well, that’s $10, will you take $5? And then the person says, well, how about $7? And then you meet at $7.

Andrew:                              17:48                     So if you think of these brokerage terms like there are the bid and the ask, that’s kind of like what somebody is offering to buy and what some of these offerings to sell. So one thing that I think maybe any investor, whether you’re a long-term investor or an active trailer, I think if the trend goes where there are more volume and more of these swings between the bids and the asks, I think you can take little percentages and get a little bit of a gain kind of right off the bat. And that could compound in the big amounts, particularly if you’re investing higher and higher capital.

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Andrew:                              18:43                     So you have the bid on how much investors are offering to pay for the stock. The ask is how much investors are offering to sell the stock for. So generally if you put an order in with your broker and you say, Hey, let me get this, I want to buy the stock, they’re going to probably get you to buy that stock somewhere in the middle. And so what you can do instead is to make a limit or there. And so the the the the the Marvel of a, what is it, the more of an opportunity that this can be for you is where the bid asks spread higher. And so let’s say like for example, I have a stock pulled up. This one’s in my E leather, and the spread is 11 cents. So that doesn’t sound like much, but we’re talking about the $15 stock.

Andrew:                              19:40                     So if you’re buying like what’s, what’s, let’s do the quick math, like a hundred shares, that 11 cents, it’s 11 bucks. That’s almost an extra share. That’s almost a percent. So what you can do instead of just like, let’s say I, I know I want to buy the stock at where it’s trading at right now, 15 for the seven. But you know, I would prefer to buy it at 1539, which is where the bid is rather than 1550, which is where they ask is. So maybe I would, what you can do is you put a limit, or they’re in, so if you put a limit or there on the buy, that means that this tells your broker, do not execute this trade unless the, unless I’m paying at most what this limit is. So if I put a limit in at 1539 and the stock is still trading at 15 for the, the Barker is not going to give me those, those shares until somebody offers me 1539 then I take that trade and you can do the same thing on the sell or you put a limit or there also, and so maybe you know, this can work great in so many ways, but like maybe, maybe you bought the stock at like 15 and you really want to get out at 1550 to get like a 50 cent profit, right?

Andrew:                              20:58                     You can put the limit or there at 1550, so it’s at 1547 now we’re not selling 1548 it rises to that 1550. Now we want to sell, and we get that 50 cents. Now there’s always a risk. There’s always a risk with anything with investing; you’ll never get anything risk-free. So there is a risk if you put a limit or their end that the stock completely turns the other way, and it never hits your limit. So you always have to keep that in mind. I think maybe a tangible takeaway from all of that is maybe you put a limit or they’re in at the beginning of the day and then near the end of the day, if, if, if you still, you know, if the stock didn’t move that low or that high or whatever, then you still execute the trade might sound, you know, like maybe, maybe we’re getting the pinching pennies at this point, but it could be another way to sort of take advantage of more actively.

Andrew:                              21:57                     The more volume there is more volatility or even, the more potential for these bid-ask spreads to widen the greater chance that you know, you can, you can do something significant. I think. I think we’re going to agree a percentage point is it can be significant, especially at a buy point, I think because that can compound that, that’s that much more of a percent of a, of a dividend you’re receiving, that’s not much more of a percent less than your pain as related to the sales or the earnings or the assets. So I think it’s something that’s worth kind of trying at least where you can kind of work with limit orders and understand that, Hey, you know, if you’re, if you’re watching the stock on an intraday day, it’s going up and down and it’s going up and down. Maybe you can capture that.

Andrew:                              22:50                     Sometimes there’s a risk that you won’t, but if the stock moves a lot on, in a short trading period there could be a good chance of, of picking up a couple of you know, a couple, a couple of half percentage points or percentage points here, here or there that could be useful. I mean, at the very, at the very worst, if you’re at least buying at the bid rather than they ask, I think that’s, that’s generally a win. What do you, what do you think? Oh, I think at a, I mean, it all sounds interesting. I honestly don’t know that much about it. Have mourning as you talk about it. I guess I have some questions about, kind of a little bit about what you’re talking about. So like when you’re deciding like what kinds of stocks to buy, are you still following the idea that you would buy value investing stocks?

Andrew:                              23:51                     Like you what I’m talking, I’m talking about like a stock thous or like, let’s say something you’ve already a use case for this, something you were already going to buy. Let’s say your dollar cost average every month. And so I want to buy, I don’t know, Johnson and Johnson, right? So right. If I was going to buy them tomorrow right now, they’re trading that one 36 17 the bids one 36 Oh one, and the ask is one 36 39 so you have a 38 cents spread. So if I’m buying like ten shares, maybe I am, I mean me personally, I would, I would try to put a limit maybe or they’re in a little bit below the bid. Okay. So you know if the bids one 36 Oh one and I put the limit or their 5 cents less than all I need is for the stock to drop like 5 cents.

Andrew:                              24:48                     And I just picked that up. Right? Right. And so that, that bid is 16. I know people can’t see my screen, but that’s 16 cents less than what the stock is trading at now. Right. So I think what’s, what’s quite cool about it is that the stock doesn’t have to like the stock could be trading at one 36 17 yet. I could buy that one 36 Oh one just because somebody has put an order in. And there’s, it’s complicated like behind the scenes how it works between how these brokers houses kind of process the orders and everything. But right. Like if, if somebody on the other end of my trade is putting the market, or they’re in and depending on how the speed of what, what orders are coming in and, and I’ve seen it just in a couple of days of playing with the bids and the, and the ask and the limits and everything. You can bet I’ve had; it’s been a hit or miss. It’s like sometimes I get too aggressive, and I’m like, well, I want it way lower than this bid price. And then it never gets executed. Right. Or, but you know, but you can take advantage and, and it takes all of two seconds to be like, well, let me at least guarantee myself the lower kind of part of it.

Dave:                                    26:13                     Yeah, that makes sense. So do these last days, hours, minutes, I mean, how, how long generally do the trades take to take effect?

Andrew:                              26:27                     That’s a good question. So with any limit or there that you make, you know, kind of the general way to, to kind of go with the brokers, you make the order, they go, they just execute that market and then you have the stocks in your like right away, right. So with a limit or there, and this is with ally bank, and I don’t know what the other brokerage houses do, but I’m assuming that’s something pretty similar. You put the order in, and then by the end of the trading day, that will expire. So if, if it never hits my trade, then that’s just gone. If, if somebody does take my offer, then that goes in as immediate as the offer was accepted.

Dave:                                    27:14                     Gotcha. Okay. Okay. So if you, if you are looking to make a transaction and it doesn’t happen at the end of the day, it expires.

Andrew:                              27:23                     Correct.

Dave:                                    27:24                     Okay. All right. That’s good to know. So is this something that, Okay, Like how do you make money doing this? Is it, it’s like putting a little hot sauce on the, on a, on a plate of food that you’re, are they going to eat? So you know, like, like for me, if I’m already, if I already know I’m on the bias stocks, it’s just adding another advantage in.

Andrew:                              27:55                     Right, right. So for you, you’re looking at it as a way of a company. Let’s say Johnson and Johnson is a company that you wanted to invest in for you, and there’s really, it’s not a lose-lose situation because if you end up getting the stock at a price, maybe you weren’t necessarily wanting, you’re still getting the company you want. Correct. Okay. Yeah. And that’s like, I mean you, you take it in any stock you are going to buy. Like I hope people aren’t stressing. Like, like for me, when I’m putting a stock from the leather, it’s like, well, whenever I have time, I’m just going to log in, boom put the order in, and then we’re done.

Andrew:                              28:36                     Right? Right. If you want to kind of play the big game, which I think is something that might come into some of this mind, and if you don’t understand those terms can get confusing, but basically it’s like, well, I’m already coming in, maybe I’m putting this in, and then I’ll wait an hour, and then if it never gets executed, I’ll just buy it the market anyway. Right, right. So you’re just trying to capture a little bit of that spread, but not freaking out, because let’s say you go back an hour later and then you’re saying, well, no matter what happens after an hour, then we’re just going to execute. Well, within those 60 minutes, there’s probably a 50 50 chance that goes either up or down — not necessarily trying to guess if it’s going to go up or down. We’re just, we’re just saying, Hey, instead of just buying in the middle, let’s set a buy point below. If it hits cool 50 50 chance of hits, then we just locked in a lower price, right. 50 50 chance, it doesn’t hit well in an hour, we’re going to buy it anyway because I’m happy we have the margin of on the stock.

Dave:                                    29:42                     We already know that this is a stock that for all the reasons, of all the episodes up to now that we’ve talked about investing for the long term. Right. That makes sense. Yeah, totally. I mean, I, I kinda like your analogy to the hot sauce thing because it’s, it’s putting it into a little bit better perspective for me because like you’re saying, I’m still going to pull the trigger on by JP Morgan cause I want to own the stock, but I’m also getting a little bit extra stuff with it by doing something like this. Yeah. Oh, that’s quite cool. I guess I hadn’t thought of it that way. And I think the thing that I, I guess is kind of interesting to me is that I guess I’ve always been frankly afraid of options because I felt like it was such a risky thing and it’s always been portrayed as gambling, I guess.

Dave:                                    30:40                     And kind of the way that you’re explaining it to me and your outlook and thought on it. It does not really cause you’re about one. We’re not talking about options. Yeah. Well, yeah, true. Okay. Nevermind. Sorry. My bad. Just then, some of them, the ins and outs, I guess of the brokerage account. I guess that’s a better way of putting it are things that I frankly was not as familiar with because generally, well, not generally. Every time I buy a stock I buy it, you know, at market and we’re done. So I’ve never really delved into these things that you’re talking about and just not as familiar with them. Yeah. I mean, I don’t know-how, what all the developments we’re talking about with the Xero commissions. I don’t know how that, if at all, if it’s going to affect how the bid and ask kind of spread moves over time.

Dave:                                    31:34                     I don’t know when it does the volatility. I don’t know. I don’t know any of that. But I think this is something that as more investors get encouraged to dig in and become more active, this is another little hot sauce thing that they can put next to all their other sauces on the cabinet that they can use along with everything else they’ve learned, hopefully so far. And maybe give yourself a little more of a boost. Yeah, exactly. I think that’s great. All right folks, we’ll, that is going to wrap up our discussion for this evening. I hope you enjoyed our conversation about continuing you. The thoughts on no commissions and how that’s affecting things. Andrew had some great ideas on the ins and outs of using your brokerage account to make a few extra hot sauces as he put it. And so that’s a, yeah, that’s going to be great stuff. So I learned a lot of it was interesting to me. If you enjoyed today’s show please subscribe to hear more. So without any further ado, we’re going to go ahead and sign off. You guys go out there and invest with a margin of safety. Emphasis on the safety. Have a great week, and we’ll talk to y’all next week.

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