Silly me!
I have recently bought into a few (8) ETFs in my portfolio. But I was laboring under a misimpression when I bought them. Because I am a beginner at this whole thing, I misunderstood the way that they work.
I thought that the price of the ETF was based on the value of the stocks that were held in the ETF. For instance, let’s say that an ETF hold 2 stocks (I know that doesn’t happen, but this is just an example of my thinking) and it holds the same amount of both stocks. I thought that if one of the stocks holdings goes up by 1 dollar and the other goes down by 50 cents that the ETF price would reflect a 50-cent increase.
Apparently, the ETF price has nothing to do with the value of the stocks held. Instead, the price goes up and down based on how many shares there are and how many are being sold. Just like a stock in a single company. I wasn’t too happy when I learned that about stocks either. I thought that if a company did well that the stock price went up but found out that the stock price goes up if investors are buying a lot of that stock because the company did well. But if there is no confidence that the profits would continue, investors may not stay involved, and the stock price goes down.
I began to wonder if the stock prices of the stocks held in the ETF had anything to do with the price of the ETF. I guess it kind of does. If you look at the information about an ETF, you will see a measurement called NAV. It stands for something, which I cannot remember but it doesn’t matter. What it means is that it is an average of the value of all the stocks held in the ETF.
As a general rule, it will be close to the going price, but not exactly the same. The point of knowing that information is that if the NAV is lower than the price, you are paying more for the ETF than the stocks inside it are worth. If the NAV is higher than the price, you are getting a deal. That doesn’t mean that if the NAV is lower that you shouldn’t buy it, because any of the stocks in the ETF might shoot up and bypass the NAV.
Something to keep in mind is that the NAV is only calculated once a day, usually after the closing of the market. Some reporting services have something called an iNAV which is an interday reading. Mine doesn’t but I’m told some do. Basically, it’s only there to let you know if you are paying more than the stocks were worth at the time the NAV was calculated, and I suppose that if the difference isn’t too big, it’s still a good buy if the stocks are going to go up.
For me, this is a bit more than I counted on and I think I will go back to buying individual stocks rather than ETFs. I may increase my position in the ones I have by adding to them a little at a time, but I think anything new will be the single stock. Just because it makes more sense to me!
