Couch Potato Basics, Part 4: Flexibility

This post is the fourth in a five-part series outlining the primary benefits of the Couch Potato strategy.

Anyone who has invested in both mutual funds and individual stocks knows there’s a world of difference in how they are traded.

You can determine a stock’s current price almost instantaneously. If you place a market order to buy a popular stock, chances are your trade will be executed in seconds, extremely close to the quoted price. And if you’re adamant about receiving a particular price, you can place a limit order, which specifies the maximum you’ll pay when buying, or the minimum you’ll accept when selling. You can do this any time the markets are open.

Mutual funds are far less flexible. Funds calculate their net asset value (NAV) just once daily, after the market closes, and then carry out trade orders made during that day. So even if you place an order to buy or sell at 10 in the morning, the trade will be executed based on the price set at end of that trading day. If you’re moving a large sum, a market drop of even 1% or 2% can cost you a significant chunk of money. Of course, a price move might also work in your favour, but the point is that with mutual funds you never know exactly how much you’re paying when buying units, or how much you’ll receive when you redeem them.

Couch Potatoes need to understand that index mutual funds are not immune to this problem: they trade exactly the same way as actively managed funds. Exchange-traded funds (ETFs), however, offer investors far more flexibility. Because ETFs are bought and sold on an exchange, they trade like stocks. You can buy them at market prices throughout the trading day, and you can use limit orders to ensure you know exactly how much you’re paying when you buy, or receiving when you sell. That greater flexibility means more options and fewer surprises for investors.

Part 1 : Low costs

Part 2: Pure asset allocation

Part 3: Transparency

Part 5: Tax efficiency

2 Responses to Couch Potato Basics, Part 4: Flexibility

  1. stamperitis January 24, 2010 at 2:56 pm #

    Just a little heads up. To limit buy and sell prices some on-line services limit it to blocks of 100 shares. So if you don’t own a hundred shares or aren’t buying a hundred shares then you won’t be able to place a limit. Scotia-McLeod is one such on-line service that has the limit.

  2. Ben January 25, 2010 at 3:35 pm #

    Another buyer beware on this issue is to factor in currency conversion. Even market order ETF trades are executed based on currency conversion at end of the trading day with an additional 2.5% fee. Once you factor in unknown conversion rates applied at the end of the day, US$ ETFs end up as inflexible as mutual funds where you don’t know the cost of your trades.

    I wanted to buy a specific sum of VTI recently from Scotia-McLeod and it came down to a guessing game. I did my math as 1 USD bounced around C$1.02. I was later surprised to see the confirmation come in well over my expectation or Scotia’s equity order estimator due to currency conversion at 1.06!

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