Understanding The ETF’s Net Asset Value (NAV), Premium, Discount and Commissions

ETF premiums and discounts

Unlike no-load mutual funds, you don’t purchase ETFs at their NAV, nor do you sell them at this value. Instead, ETFs are traded at their market price, similar to individual stocks. If there’s high demand and other investors are buying when you purchase, you might end up paying more than the NAV. Conversely, if the majority of investors are selling when you buy, you might pay less than the NAV.

When an ETF’s market price is above its NAV, you’re buying or selling at a premium; when it’s below, you’re buying or selling at a discount. Typically, these premiums or discounts are minimal, and the more popular the ETF, the smaller the discrepancy between its market price and NAV.

You can check an ETF’s premium or discount through the exchange it trades on, consult your financial adviser, or look it up on financial websites. A distinctive feature of ETFs is that authorized participants—usually institutional investors or market makers—can create or redeem large blocks of shares at the NAV using baskets of the fund’s underlying securities. This mechanism helps keep ETF prices closely aligned with their NAVs and prevents the large premiums or discounts often seen with closed-end mutual funds.

However, the ETF market includes some funds that are narrowly focused, linked to unconventional indexes, or actively managed. As a result, liquidity and the alignment of market price with NAV may not be as consistent across all ETFs as it is with the most popular funds.

Multiple uses

ETFs have seen increasing popularity since the SPDR S&P 500 ETF launched in 1993. Their appeal largely stems from their typically low expense ratios, versatile applications, and the convenience of achieving diversification through a single trade.

ETFs can be purchased in taxable accounts, IRAs, and Coverdell ESAs, provided the custodian is a brokerage firm or has a brokerage division. They are also available in some employer-sponsored retirement plans, such as 401(k)s, especially if the fund is a commingled trust or if the plan provider offers proprietary ETFs. Additionally, target date or lifecycle funds may include ETFs, and ETFs can be part of the age-based tracks in a 529 college savings plan.

The commissions

Because ETFs are traded on exchanges, investors typically pay a commission to buy or sell them, unlike no-load mutual funds, which are purchased directly from and redeemed with the issuer. This cost difference is sometimes cited as a reason to choose index funds over ETFs that track the same index.

However, many brokerage firms offer fee-free transactions for a select group of ETFs. This list may include funds from various major providers or, in some cases, only proprietary funds.

While avoiding transaction fees is appealing, it’s crucial to conduct thorough research before buying. Some commission-free ETFs are highly rated, very liquid, and have low expense ratios, but this is not always the case. ETFs with higher-than-average expense ratios might end up costing more than the modest commissions on many ETF transactions. Additionally, selling an ETF before a firm’s specified deadline might result in higher costs or reduced flexibility. If a less-liquid ETF has a significant discrepancy between its NAV and market price, you could end up paying more when buying or receiving less when selling.

It’s also important to check whether a commission-free option offers a sufficiently broad range of diversified funds. These considerations don’t negate the potential savings of commission-free trades or the possibility of building a high-quality portfolio with them. They simply highlight the need for careful evaluation of all investment aspects before making a decision.

Understanding The ETF’s Net Asset Value (NAV), Premium, Discount and Commissions by Inna Rosputnia

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