Market Decimalization and the Rise of ETFs

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Market Decimalization and the Rise of ETFs

Postby Boglenaut » Fri May 03, 2013 10:44 am

While I strongly favor Admiral shares over ETFs, I still have an interest in ETFs in regards to investing theory.

I have a theory that I haven't seen posted here before. My theory is this:

If U.S. Markets did not convert to Decimals in 2001, ETFs never would have become so popular. This is because the larger spreads would have discouraged their use and ETFs would have remained a niche product only in specialized areas. investors willing to pay a one or two penny spread for a Total Market or S&P 500 would not have paid 6 cents.

From http://www.investopedia.com/terms/d/decimal-trading.asp

Decimalization has led to tighter spreads since smaller price movements can be accounted for. For example, prior to decimalization, one-sixteenth (1/16) of $1 was the minimum price movement represented in a price quote (this is equal to $0.0625).

With decimalization, the minimum price movement is 1 cent for stocks over $1, providing a greater number of price levels and allowing for tighter spreads between the bid and the ask levels for trading instruments.


I have seen graphs of ETF sales volume growth but my Google searches bring up too much information to find them. If anyone has a link to such a chart (Nisiprius?), I'd be interested to see if it supports or detracts from my theory. I'd also be interested to hear from ETF experts like Rick Ferri. In today's world it seems no thought is unique, so I am sure it's been written about, but it's not a topic I have seen here.
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Re: Market Decimalization and the Rise of ETFs

Postby Peter Foley » Fri May 03, 2013 11:00 am

I have an additional theory - if the market had not converted to decimals there would be less computerized trading and individual investors would have more confidence that there was a level playing field when it came to investing.

IMHO I don't think it had much impact on the growth of ETFs. Two good reasons for ETF growth are lower expenses and the ability to buy and sell when the market is open. While the margins are usually small, I still do not like the fact that I do not know exactly the price at which I am buying or selling when I purchase shares of a mutual fund.
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Re: Market Decimalization and the Rise of ETFs

Postby boggler » Fri May 03, 2013 11:16 am

Why do you strongly favor Admiral shares?
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Re: Market Decimalization and the Rise of ETFs

Postby Boglenaut » Fri May 03, 2013 11:28 am

boggler wrote:Why do you strongly favor Admiral shares?


I don't really want to get off topic. ETF vs Mutual Fund is a topic that's been discussed endlessly (I actually became a Boglehead poster to ask ETF questions). See the Wiki for the Pros and Cons:

http://www.bogleheads.org/wiki/ETFs_vs_Mutual_Funds

It's generally a personal preference and I respect that. For me, I saw the need to set my own price (won't risk market orders) and trade during the day as big disadvantages. I like to just say buy/sell so many dollars (not shares) of a fund the night before payday and forget it.
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Re: Market Decimalization and the Rise of ETFs

Postby nisiprius » Fri May 03, 2013 1:01 pm

Along vaguely tangential lines, I'd wondered what the explanation was for the boom in popular stock market investing in the 1920s. I may have found one, or, at least, a missing piece in the puzzle.

In The Great Depression: A Diary, Benjamin Roth writes that "Without being able to explain it, the fact remains that after the war people became stock market conscious." But the editors note: "Entering the stock market became a lot cheaper by the 1920s.... all kinds of enterprises needing money to fund their operations began splitting their shares into smaller and smaller amounts so more Americans could 'own' a part of a company. Furthermore, cheaper 'common stocks,' stocks with no guaranteed return if the company wasn't profitable, gained popularity in the 1920s. They carried higher risk, but they were also less costly than 'preferred' stocks...."

Little changes can have big consequences.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Re: Market Decimalization and the Rise of ETFs

Postby jon-nyc » Fri May 03, 2013 1:10 pm

I don't know - decimalization didn't hurt, but SPY was considered wildly successful before then and was being emulated by others. I think ETFs would have grown in popularity in a fractional environment as well, IMO.
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