What is Implementation Shortfall?

In the financial world, an implementation shortfall is a term used to describe the disparity between the decision price of a given security and the final execution price associated with the purchase. Sometimes referred to as slippage, this type of shortfall takes into consideration any and all fees associated with the actual process of conducting the trade. The goal of the investor is to minimize the amount of implementation shortfall that takes place, thus keeping the overall cost of acquiring the security as low as possible.

In order to understand how an implementation shortfall works, it is first necessary to define what is meant by a decision price and a final execution price. The decision price is simply the posted cost per share of a given security. This price may be the closing price of the security at the end of the trading day, or the current price of the security at the time when the investor authorizes a broker or dealer to make the purchase, such as at the beginning of the new trading day.

By contrast, the final execution price involves additional factors. Along with the paying of the rate associated with the security itself, the final execution price also includes any applicable taxes and fees that are assessed as part of the purchase process. This figure includes any broker fees applied, any taxes levied by local tax regulations, and any other assorted charges that are commonly assessed by the brokerage.

The goal of the investor is to incur as little of an implementation shortfall as possible. For this reason, a savvy investor will seek to utilize a reputable brokerage that offers the lowest in transaction fees. This can include such factors as the flat rate per transaction that is usually assessed by the brokerage, as well as looking for brokers that choose to absorb a larger portion of the trading fees that are commonly assessed by some of the major markets around the world. The investor will also seek to find ways to minimize the tax burden associated with the acquisition of the security, although in some nations that is not a possibility.

There is no way to completely avoid incurring some type of implementation shortfall, unless the broker is willing to waive all fees and be responsible for all taxes and trading fees that are assessed on the purchase. Since that is highly unlikely, it is important for the investor to look closely at the final execution price as well as being mindful of the decision price. Taking the time to do so makes it possible to determine the actual out-of-pocket expense associated with acquiring the investment option, and decide if the true cost is actually worth the risk.