The ETF portfolio and your trade have different prices

An ETF's reported net asset value and the price at which its shares can be traded are different observations. A buyer who pays above NAV starts with an extra amount to recover. Later growth in NAV need not be large enough to cover it.

The SEC's ETF bulletin describes a market price above NAV as a premium and a price below NAV as a discount. Retail investors generally buy and sell on the exchange at market prices.

Record the premium

Use an invented ETF with a $25 NAV per share and an executable purchase price of $25.50 at the same instant. An investor buys 200 shares for $5,100. The shares represent $5,000 of NAV at that observation time.

The $0.50 premium divided by $25 NAV is 2 percent. Its denominator is NAV, not the purchase payment. The investor has spent $100 more than the corresponding NAV amount, without acquiring additional shares.

Follow the later sale

At a later date, supply a $25.25 NAV and an executable sale price of $25.25. The investor sells all 200 shares for $5,050. Assume no distributions, splits, fees, taxes or other transactions between purchase and sale.

NAV rose 1 percent. The premium fell from 2 percent to zero. The trade lost $50 against its $5,100 cost, approximately 0.98 percent. These results describe the same supplied record. They do not establish that a premium always disappears or that buying below NAV assures a profit.

Had the later sale price instead been $26 with everything else unchanged, proceeds would have been $5,200 and the trade would have gained $100, about 1.96 percent. The investor's result follows the actual transaction prices and distributions, not NAV alone.

Separate spread from premium

Consider a separate quote with a $24.95 bid and a $25.05 ask, each available for 200 shares. Buying at the ask costs $5,010. Immediately selling at the unchanged bid returns $4,990, a $20 loss before other charges.

The spread compares two executable prices. A premium compares a market price with NAV. The fund expense ratio describes recurring operating costs. Labeling all three as the fee hides their different mechanisms.

Align the observations

Do not silently compare yesterday's closing NAV with today's live share quote as if both were simultaneous. Record the valuation dates and times. The examples above supply matching observations to isolate the arithmetic.

ETF creation and redemption activity can help keep prices near NAV, as the SEC explains. It does not promise a particular execution for a retail order. Quantity, available quotes and the underlying valuation information still matter.

For the decisions and obligations behind a business owner's figures, read the opening of Infinite Upside.