Start with what it means to own a company share
Buying a company's stock gives you a small ownership stake in that company. The amount people pay to trade a share is its share price. If the price rises, your shares are worth more. If it falls, they are worth less.
You might want to invest in several companies. A fund pools money from many investors and uses it to buy investments under a stated plan. When you buy a share of the fund, you own part of the fund. Changes in the value of its investments affect the value of your share.
An ETF is a fund whose shares trade on an exchange, a market where people buy and sell investments. Buying an ETF puts ETF shares in your account. You do not receive separately owned shares of each company the fund holds.
Follow $1,000 invested across three companies
Our invented ETF holds just three stocks, with no cash or liabilities—money it owes. You buy $1,000 worth of ETF shares at the value of the investments behind them. Nothing is traded during the period, there are no fees, and the fund pays no cash to investors.
The fund starts with 50% of its money in company A, 30% in B and 20% in C. Your $1,000 therefore represents $500 invested in A, $300 in B and $200 in C. Each percentage is a weight: it tells you how much of the fund's money goes into that holding.
Now A's share price falls 10%. The $500 in A loses $50. B's price rises 5%, so the $300 in B gains $15. C's price stays unchanged. The $50 loss is larger than the $15 gain, leaving a combined loss of $35. The investments behind your ETF holding are now worth $965.
Scroll wide tables sideways. Keyboard: focus the table, then use the arrow keys.
| Holding | Starting weight | Starting amount | Stock return | Gain or loss |
|---|---|---|---|---|
| Company A | 50% | $500 | −10% | −$50 |
| Company B | 30% | $300 | +5% | +$15 |
| Company C | 20% | $200 | 0% | $0 |
| Total | 100% | $1,000 | −3.5% | −$35 |
The −3.5% in the last row means that you lost $35 out of the starting $1,000. You can also add up what remains: $500 × 0.90 + $300 × 1.05 + $200 = $965. The 0.90 means 90% of A's starting value remains; the 1.05 means B is worth 105% of its starting value.
B went up, yet the fund lost money. A fell by a larger percentage, and more money was in A to begin with. Counting how many stocks an ETF owns would miss both parts of that explanation.
Several company names can hide the same risk
Suppose A and B work in the same industry. Their starting weights of 50% and 30% add up to 80% in one industry. A problem in that industry could push both share prices down. You have three company names, but most of your money depends on companies affected by the same problem.
Spreading money across different investments is called diversification. Buying another ETF may not spread it much further if that fund owns many of the same companies. You could end up putting more money into the same large holdings; our overlap examples show how to add the weights. Even a widely spread stock ETF can lose money when the whole stock market falls.
The three-company example explains how weights affect a result. Other ETFs can hold bonds, which represent money lent to an issuer such as a company or government. A bond ETF is affected by market interest rates and the issuers' ability to repay. It need not return your purchase price on a fixed date, as explained in bonds versus bond ETFs.
Foreign investments also involve exchange rates: the rates at which one currency is converted into another. A change in that rate can affect your result. A currency hedge is an arrangement intended to offset specified exchange-rate movements; it does not cover losses in the investments themselves. The policy rate on our map cannot predict an ETF's next return.
Buying the fund means agreeing on a price
You normally buy or sell ETF shares on an exchange during trading hours. Buyers offer prices and sellers ask for prices; these are their quotes. A trade happens when an available order matches the terms of your order. The price actually paid per ETF share is the market price. The fund does not promise to trade with you at the amount shown on your screen.
There is also a value calculated from what the fund owns. Add up the value of everything the fund owns, subtract what it owes, then divide by the total number of fund shares. The result is net asset value per share, or NAV. It is the net value of the investments behind one share. It can differ from the market price you pay.
A conventional mutual fund is bought from the fund, often through a bank or broker. To take money out, you ask the fund to exchange your shares for cash; this is called redemption. An eligible US mutual-fund order generally uses the next calculated NAV after the order is received. The SEC's comparison explains that pricing difference. Cut-off times, fees and redemption arrangements elsewhere depend on the product and local rules.
The collection of investments a fund holds is its portfolio.
| Investment | What one share represents | How a retail order is priced |
|---|---|---|
| Company stock | An ownership interest in one company. | An exchange trade executes at a market price, subject to the order's terms. |
| ETF | An interest in a fund's portfolio. | An exchange trade executes at a market price, which may differ from NAV. |
| Conventional US mutual fund | An interest in a fund's portfolio. | An eligible purchase or redemption generally uses the next calculated NAV, with applicable fees or charges. |
The ETF label does not tell you what it invests in
Some ETFs concentrate on one industry or even one stock. Others use derivatives: contracts whose value depends on an asset, index or another underlying measure. An index is a number that tracks the performance of a selected group of investments. Our three-stock example does not describe every ETF.
An index fund aims to follow the performance of an index. Both ETFs and conventional mutual funds can do that. In an actively managed ETF, a manager selects investments within the fund's stated objective. Knowing that a product is an ETF tells you how its shares trade; you still need its investment objective to understand the strategy. The label alone does not tell you the costs either.
What happens if you pay $50.50 for $50 of net assets?
Suppose a fictional ETF has a NAV of $50 per share, but the market price you pay is $50.50 at that same moment. The net value behind your share is $50. You have paid $0.50 more.
That extra $0.50 is 1% of the $50 asset value. Paying above NAV is called buying at a premium. Here the premium is 1%: ($50.50 ÷ $50 − 1) × 100 = 1%.
If NAV stays at $50 while the market price returns to $50, you lose $0.50 per share. Your loss is about 0.99% of the $50.50 you paid, before costs. It is the same $0.50, measured against a different starting amount. The investments behind the share have not lost value, but the extra amount you paid has disappeared.
A market price below NAV is called a discount. Neither a premium nor a discount is a promise about the next price movement. A limit order lets you specify the most you are willing to pay, but it cannot guarantee a seller will accept it.
The two values also need to refer to the same time. Comparing yesterday's NAV with this minute's market price mixes in any change in the investments since yesterday. An intraday indicative value is an estimate during trading hours, not a guaranteed dealing price. Foreign holdings may also trade in different hours.
Count the cash you receive as well as the price change
A fund may pay cash to its investors. That payment is called a distribution. Looking only at a share-price chart leaves this cash out.
Suppose you buy one ETF share for $50. It ends the period at $51, and you also receive a $1 cash distribution. You keep the same share and hold on to the cash, rather than using it to buy more shares. You pay no tax or trading costs in this fictional example.
The share is worth $1 more than you paid, and you have another $1 in cash. Together they give you a $2 gain, or 4% of the purchase price. A price-only chart shows 2%. If the price had fallen by more than the cash distribution, the overall result would be a loss.
Before comparing returns, check whether both figures include distributions and whether both assume the cash is used to buy more shares. Buying more shares with the cash is called reinvestment. Our distribution examples follow the cash and the share price separately.
Running a fund also costs money. Fund operating expenses are paid from fund assets, so they may reduce your return without a separate withdrawal from your account. Do not subtract the same expense again from a NAV return that already includes it. Your brokerage or currency-conversion charges may still be outside that figure.
Finally, buying and selling can cost you money even when prices stay still. The bid is what a buyer offers; the ask is what a seller requests. Their gap is the bid–ask spread. If you buy at the ask and immediately sell at the unchanged bid, you receive less than you paid. A low annual fund fee does not remove this trading cost.
Sources and assumptions
- SEC Investor.gov: mutual-fund and ETF trading — the US next-calculated-NAV pricing description.
The holdings, prices and calculations are hypothetical, not product offers or forecasts. Each example states its assumptions about costs, taxes and distributions. The US mutual-fund pricing description is specific to that market; other account and redemption rules depend on the product and jurisdiction. Editorial policy.