When the average Joe (or Jane) looks at transactions costs from trading, they typically focus on the commission charged by the broker. But in the case of some thinly-traded ETFs (exchange-traded funds), the bid-ask spread can add significantly to that cost. Here's a good piece on the topic from Morningstar:
No one has a very precise definition of liquidity, but it roughly boils down to how easy it is to buy or sell a particular security and how much agreement there is in the marketplace upon the security's fair value. The most liquid funds or stocks have miniscule bid-ask spreads, where the prices differ by only a penny. On the other side, a brand new ETF tracking a selection of more thinly traded mortgage-backed securities has a bid-ask spread near 0.80% as I write this. That means that buying and selling the fund at market prices, even without any commissions charges or price changes, would result in a 0.80% loss. Not exactly a terrifying loss, especially compared with what we all saw in 2008, but still an unwelcome drag on portfolio returns if it can be avoided.
Read the whole thing here.