Investing 101

_In short: ETFs are wrappers around baskets of securities, such as the 500 stocks of S&P 500. Sometimes the price of the ETF diverges from the average price of its securities, making it expensive or cheap versus its Net Asset Value._

Exchange traded funds are one of the ways investors can gain exposure to several assets without taking individual positions in any of them. ETFs trade throughout the day, similar to their underlying stocks. For example, investing in the SPDR S&P 500 ETF (SPY) gives investors exposure to the 500 underlying assets without the risk of holding each asset. 

**So how do you value the position then?**

The value of both mutual funds and ETFs are calculated using the net asset value (NAV), which uses the end of trading day price for each underlying asset. The NAV of an ETF is equal to the value of each share measured by the value of all the fund’s underlying holdings at their closing price for the day. However, because an ETF trades throughout the day, this measure can only be calculated at the end of the trading day. If you’re interested in calculating a more precise performance, investors can use the intraday net asset value (iNAV). 

**NAV = (assets - liabilities) / ETF shares outstanding**

At a given time, the market price of an ETF is dependent on the intersection of its supply and demand in the market. However, the NAV is an important value because if the market price deviates too much from the NAV, institutional investors will engage in trades to arbitrage the price back closer to its NAV. Therefore, one can assume that the market price of a liquid ETF will often be very close, if not equal, to its NAV.

If there is a discrepancy between the market price of an ETF and its NAV, institutional investors will sell the ETFs and buy the underlying basket of stocks (if the ETF price rises too high above the NAV) and vice versa (if the market price falls well below the NAV).  

**How is an ETF’s daily NAV computed?**

Using the most recent closing prices of the ETF’s holdings (on a weighted basis - individual asset value versus total portfolio value), **plus** any cash, _minus_ any liabilities that the ETF may have on its balance sheet and finally **divided** by the total number of ETF shares outstanding. 

_For example, if the NAV of X ETF is $100, you buy 10 shares worth and then a few months later, the NAV is $115. You have made a profit of $15/share._


Did you know the NAV of an ETF can tell you whether its trading at a premium or a discount? 

Calculating the value of an ETF

Exchange Traded Funds (ETFs)

Along with low fees, ETFs are a good addition to your portfolio because of their tax efficiency. Rather than individually investing in a basket of securities and getting taxed on each capital gain, by investing in ETFs, you only get taxed on the gains you earn from the ETF. 

Even if you choose to hold your ETF forever, you can still earn capital gains at the end of the year if the fund manager decides to sell the underlying securities. This is calculated by taking the gains from the year and subtracting the losses - the difference is distributed to shareholders as capital gains. Since most ETFs track an index like the S&P 500 or the Nasdaq, a manager only sells underlying securities if there is a change in the index’s holdings, which rarely happens. As a result, there are fewer capital gains to report at tax time, especially compared to active funds which aim to beat an index. 

Essentially, the more you trade, the more potential capital gains but the higher taxes you will have to pay. As a result, investing in passive ETFs and holding these investments for a long term provides you with the highest tax efficiency, unless you’re using an IRA account to trade. 

The amount you will have to pay in taxes depends on the tax rate and how long you hold a security for. If you hold a security for longer than 1 year, you will be charged a lower tax rate versus holding a security for less than a year. 

For institutional investors, shares of an ETF can be redeemed in exchange for a basket of securities held by the fund. As a result, the fund never has to sell shares of its underlying securities to generate cash and this avoids generating taxable gains since these events are not considered as “taxable.” 

Tax Structure of ETFs

Calculating the value of an ETF