schooner wrote: ↑
Fri Jun 14, 2019 11:13 am
chisey wrote: ↑
Fri Jun 14, 2019 11:09 am
schooner wrote: ↑
Fri Jun 14, 2019 10:27 am
True, but you would not be following your AA anymore. Plus, ordinary investors are putting away smaller amounts through DCA. If you’re investing $500 every paycheck, that’s real drag, with opportunity costs compounded over decades.
You are seriously overstating how much drag results from this issue.
Let's take a particularly bad hypothetical situation where you have $500 to invest into a 3-ETF portfolio each month (split 1/3-1/3-1/3), and each ETF costs you $126 to invest in. Suppose your portfolio returns 12% and cash only returns 1%.
In the first month, you can buy a share of each but it leaves you with $122 left in cash for a whole month. Each month, you add another $500 but only buy shares if you can buy them in proper proportion.
Do this for 30 years. How much does the cash drag hurt you?
The answer: 1.7 basis points in annual returns over 30 years. In dollars? $1,520,866 vs $1,526,007.
It's a tiny effect because over time, the average cash balance is only $190 vs. a portfolio that gets several orders of magnitude larger than that within a few years.
True, but why give up $6,000 for ETFs? Plus the costs from the bid ask spread. When you can use a traditional index mutual fund?
I think others have also pointed this out including Nispirus just earlier, but the $6k in that example is not a 'loss' except under very limited assumptions. In general the investor almost always has *some* money in cash anyway. Even if you call it an 'emergency fund' which 'doesn't count in my allocation', cash is cash in reality. And if the investor does have 100%, of everything, in stock they can just slightly adjust the stock % upward to correct for the inadvertent periodic cash accumulation due to the transaction mechanics of an ETF. And even if the investor does not do that, the difference what cash earns at a given time and what you *want* stocks to earn is not a 'loss'. You have to factor in risk. Likewise, comparing past ex-post historical returns of cash and stocks and calling the difference a loss for holding cash, not accounting for the difference in risk the investor faced ex-ante, is not correct analysis.
But besides all that, focusing on little amounts of money left in cash to buy integer number of ETF shares is looking at a particular tree and ignoring the forest. If you build up (at some, one hopes fairly early stage) to 5X living expenses in stock MF's and a 1X 'emergency fund' there's a much bigger drag there (albeit again you have to risk adjust it) than the little rounding amounts in buying integer number of ETF shares. Whereas, if you have 5X living expenses in ETF's at a broker with good margin rates (which means Interactive Brokers, basically, among at all retail oriented shops AFAIK), you could plan to borrow 0.5X living expenses in an emergency against the ETF's, with basically zero probability of margin call (ie. borrow 10% of value, IB allows typically ~70%, so stocks have to monumentally implode to generate a margin call), and no ongoing cost (you only borrow *in an emergency*). Then you could hold only 0.5X in 'emergency fund' cash. That reduction in drag would swamp the one you are focusing on. The ability to use ETF shares as collateral for emergency liquidity is a significant advantage over MF shares, and it's hard to reach an ambitious financial goal just using 401k/IRA so eventually the ability to borrow contingently rather than hold all reserves in cash often becomes relevant in a successful portfolio.
In short the cash drag argument has little validity in general IMO.
The argument about bid-offer has some potential merit. And separately, the liquidity argument can cut in either direction depending what circumstance (the harm you can suffer as *non-selling* shareholder when an MF cashes other people out at unrealistically high NAV in a fast moving crisis, which you're not subject to as ETF holder v. the discount to NAV in market price you might suffer as *selling* shareholder of ETF shares v getting out of MF at end-of-day NAV). Again, the behavioral stuff depends on POV. I believe Jack Bogle earned a right to the paternalistic POV he took toward the interests of small investors in general. But I don't trade unnecessarily, so the fact that ETF's might temp other people to do so is not directly relevant to me. Similarly 'studies' quantifying that, not my problem. And the focus on this forum AIUI is supposed to be individual, and not 'we have to do something about this' kind of topics or approaches to topics.