The bid-ask spread is the most important trading cost that most ETF investors never think about. While everyone knows about expense ratios, the spread you pay every time you buy or sell can actually cost more than the annual management fee — especially if you trade frequently. Understanding how spreads work, what causes them to widen, and how to minimize their impact puts real money back in your pocket.
What Is the Bid-Ask Spread?
Every ETF has two prices at any given moment. The bid is the highest price a buyer is currently willing to pay. The ask (or offer) is the lowest price a seller is willing to accept. The difference between these two prices is the spread.
For SPY, the spread is typically just $0.01 — you might see a bid of $520.45 and an ask of $520.46. For a niche emerging market ETF, the spread might be $0.15 — a bid of $32.10 and an ask of $32.25.
When you buy an ETF with a market order, you pay the ask price. When you sell, you receive the bid price. This means you pay half the spread on each transaction. A round trip (buy and sell) costs you the full spread. On 100 shares of an ETF with a $0.10 spread, that is $10 per round trip — not huge on its own, but it adds up with frequent trading.
Why Spreads Matter More Than You Think
Let's compare the bid-ask spread cost to the expense ratio for a concrete example. Consider two ETFs that track the same index:
ETF A: 0.03% expense ratio, $0.01 spread on a $300 share price (0.003% spread cost per transaction).
ETF B: 0.10% expense ratio, $0.30 spread on a $50 share price (0.60% spread cost per transaction).
If you buy and hold for a year, ETF B costs you 0.10% in expense ratio plus 1.20% in round-trip spread cost (0.60% x 2) = 1.30% total. ETF A costs 0.03% plus 0.006% = 0.036% total. The spread cost dwarfs the expense ratio for ETF B.
For buy-and-hold investors who trade once per year, spread costs are manageable. For active traders making dozens of trades per month, the cumulative spread cost can be the single largest drag on returns.
What Causes Wide Spreads
Low trading volume: ETFs with fewer participants have fewer market makers competing to provide liquidity. Less competition means wider spreads. This is the most common cause of wide spreads in niche or newly launched ETFs.
Illiquid underlying holdings: If the ETF holds thinly traded stocks, emerging market bonds, or exotic assets, market makers must account for the difficulty of hedging their positions. They widen spreads to compensate for this risk. An ETF holding small-cap frontier market stocks will always have wider spreads than one holding S&P 500 stocks.
Market volatility: During high-volatility periods (VIX spikes, flash crashes, crisis events), market makers widen spreads to protect themselves from rapidly changing prices. The 2020 COVID crash saw ETF spreads widen 5-10x their normal levels for several days.
Time of day: Spreads are widest at market open (first 15 minutes) and during after-hours sessions. They are tightest during the mid-day session from roughly 10:00 AM to 3:30 PM Eastern when participation is highest.
International ETF timing: ETFs holding foreign stocks have wider spreads when the underlying markets are closed. A Japan ETF will have wider spreads during US hours because the underlying Japanese stocks are not trading, making it harder for market makers to hedge accurately.
How Market Makers Set Spreads
Market makers are firms that continuously post bid and ask prices, providing liquidity to the market. They profit from the spread — buying at the bid and selling at the ask. The spread compensates them for three things:
Inventory risk: Holding ETF shares exposes market makers to price moves. Wider spreads compensate for this risk, especially in volatile ETFs.
Adverse selection: Informed traders (institutions with better information) tend to trade in size. When a market maker sells to an informed buyer, they likely lose money. Wider spreads protect against this.
Operating costs: Technology, personnel, and capital all cost money. High-volume ETFs like SPY generate enough trades to cover costs with tight spreads. Low-volume ETFs need wider spreads to be economically viable for market makers.
How to Minimize Spread Costs
Use limit orders. This is the single most effective step. Instead of accepting the ask price (market order), place a limit order at the midpoint between bid and ask. For an ETF with a bid of $50.00 and ask of $50.10, place your buy limit at $50.05. You may not always get filled, but when you do, you save half the spread.
Trade during optimal hours. The window from 10:00 AM to 3:30 PM Eastern consistently offers the tightest spreads. Avoid the open and close unless you have specific reasons to trade at those times.
Choose high-volume ETFs for core positions. For your largest holdings — the 70-80% of your portfolio in core index exposure — use the most liquid ETFs available. SPY and VOO track the same S&P 500 index, but SPY typically has a tighter absolute spread for large orders.
Compare similar ETFs. When two ETFs track the same or similar indexes, check their spreads before choosing. The spread difference can outweigh small differences in expense ratio, especially for positions you trade frequently.
Be patient with limit orders on less liquid ETFs. If you are buying a niche ETF with a wide spread, place your limit order near the midpoint and wait. Market makers often fill patient limit orders because it reduces their inventory risk. There is no rush — give it 15-30 minutes before adjusting your price.
Spread Cost and Expense Ratio: The Total Cost Framework
Smart ETF investors think about total cost of ownership, which includes the expense ratio, the bid-ask spread, and any premium or discount to NAV. For a long-term holder who buys once and holds for 10 years, the expense ratio dominates. For an active trader who turns over positions monthly, the spread dominates.
A useful rule of thumb: multiply the spread cost per transaction by the number of expected round trips per year, then add the expense ratio. Compare this total cost across similar ETFs to find the cheapest option for your specific trading frequency. Use the ETF directory to compare funds and check current volume and liquidity metrics. For more trading insights, visit our education center.
