General

What is impact cost in ETFs?

Impact cost in the invisible cost you pay for the lack of liquidity at your desired market price.  Let’s you want to buy 1 Cr units of gold ETF from the market. Let’s say the fair value of each Gold ETF is ₹10. When you place the order, your order will be matched against multiple sellers who want to sell their units. If the volume of sellers who want to sell at ₹10 is not enough then your order starts to execute with sellers at higher asking prices (say ₹10.10). By the time your order gets fully executed your average cost could be ₹10.7 per unit.

Now what you should have paid = ₹10 x 1 Cr = ₹10 Cr

What you actually paid = ₹10.7 x 1 Cr = ₹10. 7 Cr

Here the difference of ₹0.7 Cr or ₹70 Lakhs is the hidden cost known as the impact cost (0.7%).

This cost is not charged by the broker or AMC but is a purely market driven factor. Even when the ETF itself may have lower expense ratio or lower tracking error, impact cost can reduce your returns. This is especially true for frequent traders and large orders.

ETFs with high impact cost:

a. ETFs with low liquidity i.e. ETF where there are few buyers and sellers

b. ETFs with large bid-ask spread