Trading when the market is having trouble finding a price – as in the middle of a panic such as the one we are experiencing now – is risky business.

That is why it is best to trade as little as possible (Passive Low cost) and to own funds whose average daily volume (ADV) is a tiny percentage of their overall assets. There are other secondary liquidity factors

It is best to avoid trading now, while the market is in turmoil. It is the wrong moment, if you own the wrong investments, but going forward, consider building (or re-building) your investment portfolio with top-quality, simple investment vehicles, such as passive index funds. We prefer large, highly liquid exchange traded funds over any other investment than those backed by the full faith and credit of the US Treasury. Here are some general guidelines:

  • Choose funds with large asset values over smaller ones. High volume of trading is less likely to move the price.
  • Choose Exchange Traded Funds (ETFs) over Mutual Funds: Mutual funds are only priced once a day, but you can time your trading in ETFs, so you trade in relatively quiet time windows.
  • Choose lower-cost funds over higher cost: no matter what promises the funds make, expenses are a fundamental drag on long-term performance.

Times like the ones we are in today demonstrate why exotic investments can lead to trouble:

  • The average investor has to pay the costs of owning but also trading the stocks and funds they invest in.
  • Mutual funds and ETFs typically charge expense ratios, but they also have a bid/ask spread. Even if they have “zero” expense ratio, they are not “free” to own.
  • When markets are in turmoil, bid/ask spreads can widen, causing extra trading costs.
  • Funds or ETFs that try to synthesize an index, instead of owning its components, can have big deviations when the market is in panic. Tracking the index gets hard to do when models go off the rails.

Investopedia has an article explaining why ETF Liquidity matters:

If you must trade, avoid doing so at the market open or closed.  Also avoid trading when the market for the underlying securities in any ETF you are trading is closed.  For example, trading a bond fund on days when the stock market is open, but the bond market is closed.

Every trade takes a bite out of your long-term returns. There will be better times to rebalance, hopefully coming soon.

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