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ETF Investment Strategy & Board Lots

Personal Finance Clinic
Today’s post comes courtesy of a question from The Personal Finance Clinic held by the moneygardener, Canadian Capitalist and Triaging My Way To Financial Success.

Karen writes,

“The gist of my question: Does the concept of board lots apply in trading ETFs and why or why not?

I chose early 2008 to take direct control of my RSP portfolio and move it from a mutual fund company and separate GICs to a single TD online trading account. It turned out to have been a crazy year to implement that decision but I probably rode the losses with less stress than if I had still been wondering whether anyone was paying attention to my money. I knew that I was satisfied with my decisions long-term. My plan was to convert the portfolio from funds and GICs to ETFs. I am retired (early) with a pension and I’m no longer contributing to the RSP but not drawing income from it either. The trades to accomplish the switch had to be done within that closed system of the RSP account.

There was a learning curve but I found the niggling detail practicalities hardest to find information on. Portfolio strategy was the easy part. I set an asset allocation target and then planned sales of the mutual funds one or two at a time to fund purchases of the selected ETFs in quantities of no less than 100 units. I wanted to convert the modest portfolio (about $100,000.) with the fewest possible trades. Where I couldn’t free up enough money for my targets by selling a fund, I “parked” the partial amounts in TD funds which didn’t generate a purchase trading fee. (I still hold two of these waiting for several GICs to mature over the next two years.)

My plan is to hold about 8 ETF’s – perhaps more than I need for portfolio purposes but enough to keep me interested in reading the business section and paying the attention to my investments that I should have been doing long since.

As I continue the switch to ETFs or look at future rebalancing, should I be concerned at all over the number of units of an ETF that I hold (apart from the trading fees)? Do you have any other tips or advice on implementing the trades to convert a portfolio from funds to ETFs?

Karen,

A board lot is usually a standard number of shares an exchange (TSX, NASDAQ, NYSE, etc) defines as a trading unit. For most equities and ETF’s that trade over $1.00 a lot is a minimum of 100 shares. The reasoning for advocating for a minimum standard number of shares is to improve liquidity and minimize the volatility in spreads (difference between ask and bid prices).

An odd lot is simply any number of shares below the standard board lot. Some brokerages do charge an additional fee for odd lot transactions, but in my experience with TDW I buy a lot of odd lots and have never been charged a penny more than needed. Often an odd lot can get you a better price than a regular limit order can because the odd lot is bundled with others to create a board lot. This difference can be only a few cents, but on 90 shares or so you can save yourself approximately $1.00-$4.00.

Your ETF strategy sounds like it has its roots in the couch potato portfolio strategy which includes, in the global strategy, four ETF’s. Eight is likely an adequate number if you want to diversify a little more, but the key component to follow that you’ve touched on is the rebalancing. This strategy is meant to be a very passive investment approach where regular contributions are made regardless of market actions and rebalancing moves profits from one area to build a stronger position in another. Over time this strategy has proven to be very beneficial to an investor with discipline and the ability to execute trades without emotion.

The only suggestion I would make initially is that you ensure your transaction costs (commission) are less than 1.5% of your purchase. If your trading fees are $20/trade then you want to ensure the amount you’re purchasing/selling is more than $1350. Ideally you want to keep your transaction costs (as a % of your trade) below 1% but setting a threshold is an important decision to help you limit your trading and executing on strategy. Obviously if you have a portfolio over $200,000 and you’re making a rebalance each year of $5,000 your transaction cost is only 0.4% but the principle I’m trying to outline still stands.

Your decision to implement the plan over time as your GIC’s mature will also help to build the necessary discipline to implement this strategy effectively over time. Many investors allow their emotions or impatience to win out and setting a plan will often yield higher returns than rushing into something you’re not fully prepared to initiate.

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