ETFs aren’t priced like mutual funds, says Matt Krantz for USA Today. They hold a basket of securities, and investors can trade them as they wish, just like stocks. This trading moves the price, and often, that price is in line with the value of the underlying holdings.
If the price of an ETF gets out of line, institutions can trade them or create units, bringing the price back to where it should be. In general, this constant buying and selling of ETFs keeps their value close to the actual value of the stocks that it owns. [Risks and Rewards of ETFs.]
But sometimes, problems occur.
If an ETF is traded less frequently, the price of an ETF can get above what its true value is, called a premium. The reverse, when the market price is below the value of the assets the ETF owns, is called a discount. Premiums can also occur when a fund stops issuing new shares, which happened in the case of United States Natural Gas (NYSEArca: UNG) last year. Discounts and premiums to NAV have also been an issue in bond ETFs, thanks to market volatility. [The Cost of High Fees.]
Why should you care about discounts and especially premiums? You want to get the best value – no one wants to pay $100 for something that’s only worth $90.
You can find the discount or premium at which an ETF is trading by looking at the NAV and what it’s currently trading at.
For more stories about ETFs, visit our ETF 101 category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.