Buying ETF intraday vs. buying index fund at NAV

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
ryanpeden
Posts: 14
Joined: Sat Apr 09, 2016 3:26 pm

Buying ETF intraday vs. buying index fund at NAV

Post by ryanpeden » Mon Jan 14, 2019 4:43 pm

Hello Bogleheads,

Around a year ago, I switched from using Vanguard index funds to Vanguard ETFs in my IRA to manage a simple 4-5 fund portfolio.

Since these holdings exist within a retirement account, this decision was, of course, not driven by any tax arguments. Rather, I found that it was simpler to perform re-balancing, since I'm coordinating a desired global asset allocation over this account, a 401(k), and taxable account.

When I go to add new funds or re-balance the existing holdings in this account, I will typically execute limit orders at some point in the middle of the trading day (e.g., 1pm EST). (I avoid placing orders in the first/last hours of the day, as there is strong historical evidence suggestive of higher bid-ask spreads during those times.) I will typically set my limit price equal to 2-3 cents below whatever the current bid price is at the time of placing the order, and the order will execute within at most an hour (usually much sooner). (I understand that the order could potentially fail to execute, and am always willing to retry at a limit price closer to the bid price.)

I believe that in the long run, over many years of consistent application, this strategy will yield (in expectation) a greater return than just buying shares of the equivalent index fund at NAV on the days I choose to add money to the account.

My reason for believing that I will come out ahead is the following. If we approximate this portfolio's performance as stochastic process calibrated over any historical time interval of sufficient length, we will, of course, observe that its expected growth is positive - e.g., it has positive drift - as the US equity market has historically grown over time.

My order is being executed a time t+h (h>0 is the time between submitting my limit order and it executing) at a price less than the bid price observed at time t. If we assume that purchasing a share of an ETF at below the bid price at time t is proportionally cheaper than purchasing the share at a NAV computed at time t (Is this a reasonable assumption?), then I believe the return to be higher in expectation if using my strategy, stochastically proportional to the extra time in market (buying intraday versus buying at NAV at market close) and the "discount" I've gained by purchasing the share at a price that is (in expectation, given the aforementioned positive drift) lower than the day's ending NAV.

Even if my hypothesis is correct, the amount of money that we are talking about saving here is almost microscopic. Thus, this is but a mere thought experiment that I'm using in attempt to learn more about ETFs. (I'm buying broad market ETFs and only "trading" them to re-balance and purchase new shares, so I don't see this as trying to "time the market" in any way.)

My questions:
  1. Does this line of reasoning check out, or am I missing an obvious consideration?
  2. Much of my argument rests on the assumption that if at time t, an ETF has bid price B_t and ask price A_t, then purchasing at some price B* < B_t is proportionally cheaper than buying a share of the analogous index fund at NAV computed at time t. Of course ETFs and their corresponding index funds can have prices that are on different nominal scales (e.g., VTI and VTSMX), but their gradients (with respect to time) should be proportional. Thus, when I say "cheaper," I am simply comparing the integrals of instruments' price changes over the time in market. Is this a valid assumption, or am I oversimplifying the pricing duality that exists between ETFs and their index fund equivalents?
Many thanks in advance for your feedback and discussion.

livesoft
Posts: 64186
Joined: Thu Mar 01, 2007 8:00 pm

Re: Buying ETF intraday vs. buying index fund at NAV

Post by livesoft » Mon Jan 14, 2019 4:51 pm

Have you read the Case Study: Broker Trade Executions thread?

I might have believed all the fancy stuff that you wrote about, but after doing some of my own experiments, I think it is all poppycock. So I now use market orders, trade at the opening cross by placing orders before the market opens, trade in the first few minutes and the last few minutes, and all that other supposedly bad stuff. But sometimes I place orders in the middle of the day and use limit orders, too.

One can look at the bid/ask spread whenever they want to place an order if they have real-time Level II quotes and not 20 min delayed quotes. If the spread is 1 cent or less, then you are not going to get better than that, so one can look in that first hour or last 15 minutes or whenever and see that there is usually nothing to worry about.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
ogd
Posts: 4858
Joined: Thu Jun 14, 2012 11:43 pm

Re: Buying ETF intraday vs. buying index fund at NAV

Post by ogd » Mon Jan 14, 2019 5:27 pm

ryanpeden wrote:
Mon Jan 14, 2019 4:43 pm
Does this line of reasoning check out, or am I missing an obvious consideration?
You are missing one obvious meta-consideration: if your intraday buying, after fees and bid/ask spreads, offered you even a minuscule advantage, then you should become a day-trader and leave all of us in the dust. This follows inescapably from the premise that you can consistently find a better time to buy than the end of the day.

Assume your advantage averages to a very small 0.1% per trade -- something most of us would simply not worry about for our long term investment. Compounded over 250 trading days, this is a 28.3% yearly return that dwarfs the expected stock returns from simply "time in the market". It would make you one of the most successful traders of all time. Taxes can take a bite of this, but not enough to make it unattractive -- and you could also use an IRA, or simply compare your investment prowess against fund managers with large yachts that report pre-tax numbers only.

Assuming that you don't think you can become a fund manager with a large yacht this way, and you're still reading, then we must draw the conclusion that the advantage after fees and spreads is smaller than 0.1%. If you're actually a long term investor and will only be doing this once or twice per lifetime of the investment -- why bother with intraday strategies at all?

It's pretty simple to justify the meta-conclusion -- consistently profiting from the difference between intraday and NAV, with tools available to the small investor, is too easy. There are large numbers of Wall Street sharks (or in this case, more like piranhas) with large computer clusters connected with nanosecond links to the exchanges, PhD's on staff etc, that are looking to do just this. And they do it, pennies at a time, just not in a life-changing sort of way -- looking at hedge fund returns, just barely enough to earn their salaries.

So with the big picture in mind, you can start asking "what am I missing in the details". May I suggest you start with:
ryanpeden wrote:
Mon Jan 14, 2019 4:43 pm
I will typically set my limit price equal to 2-3 cents below whatever the current bid price is at the time of placing the order, and the order will execute within at most an hour (usually much sooner). (I understand that the order could potentially fail to execute, and am always willing to retry at a limit price closer to the bid price.)
So this may work 95% of the time, then 5% of the time (infrequently enough that it might not have happened to you yet) the market runs away from you and you end up paying $1 more than when you started rather than 2-3 cents less. Weighted by the probabilities I have [conveniently] chosen, you lose 2-3 cents on average rather than gain.

On my end, I'm pretty sure any trading strategy for a small investor should only be aimed at not getting a particularly bad deal, e.g. a flash crash or a temporarily-illiquid municipal bond ETF.

Note that I have no qualms with the proposition that you gain a little by buying a little sooner, but it's such a tiny effect that it's not worth anything IMHO. Assuming you spend half a day more in the market on average, and spreading 8% yearly stock returns over 500 half-days of trading, we get about 0.015%. Again, hardly seems worth bothering with. And if you decide it is, then I hope you spend as much or more time trying to get the money invested whole days sooner -- or later when you withdraw, by depositing on the fastest route, etc. For example, Vanguard lets me buy mutual funds the same day with money still in my bank, and I can sort of accomplish this with uncovered ETF purchases, but with ETFs I might lose it on the other end, when withdrawing, due to holds. Hard to tell at this point since the rules change over time. But really, we are talking very small change at this point.
Last edited by ogd on Mon Jan 14, 2019 9:33 pm, edited 1 time in total.

User avatar
kenyan
Posts: 2939
Joined: Thu Jan 13, 2011 12:16 am

Re: Buying ETF intraday vs. buying index fund at NAV

Post by kenyan » Mon Jan 14, 2019 5:50 pm

Similar experience to those above, though I haven't quite gone down the 'market order' route (yet). I would often try to set my limit price a bit below the current bid, and wait around for the execution. Typically worked. As noted, every once in a while it wouldn't work, and then I'd sometimes have to eat a much bigger price swing or risk waiting around a long time (days-weeks-months-years) for that buy to execute. I've mostly decided it's not worth it.
Retirement investing is a marathon.

Post Reply