Buy-and-hold investing has traditionally produced strong long-term returns. But sticking with it requires discipline, and many traders prefer to look for short-term gains from strategies that involve frequent buying and selling. With every trade, short-term-minded investors pay the price, including one hidden cost from the bid-ask spread.
In the following video, Dan Caplinger, The Motley Fool's director of investment planning, describes the bid-ask spread and explains why it has such a huge impact on investors. As Dan discusses, the difference between what buyers are willing to pay and sellers are willing to accept can be as small as a single penny per share, but with enough trades, those costs add up. Moreover, stocks with less trading volume often have wide bid-ask spreads that can amount to as much as $1 or more per share.
Dan gives some solutions for avoiding the full impact of the bid-ask spread, including sticking with the most liquid stocks and exchange-traded funds. Dan provides examples for those who want to follow the Dow Jones Industrial Average (DJINDICES: ^DJI ) , the S&P 500 (SNPINDEX: ^GSPC ) , or other major market benchmarks. For Dow investors, the SPDR Diamonds (NYSEMKT: DIA ) provide good liquidity and relatively low bid-ask spreads. Meanwhile, the SPDR S&P 500 (NYSEMKT: SPY ) tracks the S&P 500 and has rock-bottom spreads. For less liquid stocks, Dan advises caution to avoid unnecessary trading that can ramp up your bid-ask costs substantially.
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