NAV vs. market price
The NAV (net asset value) of an ETF is a static number that represents the value of a single ETF share. It’s calculated only once per day—at the end of the trading day—by taking the total value of all the stocks or bonds an ETF owns, subtracting any liabilities, and dividing by the number of outstanding shares.
An ETF’s market price, on the other hand, represents the most recent price someone paid for that ETF, on that day. It’s a real-time price driven by both investor supply and demand, and the value of the stocks or bonds in the ETF. The market price can change frequently before the closing bell, when the final end-of-day price is set.
Why doesn’t an ETF’s NAV match its market price?
Both prices convey the value of 1 ETF share, right? Yes, but the NAV reflects the previous trading day’s activity and remains the same throughout the next trading day, while the market price may be constantly changing. The numbers rarely match.
On a day when the markets are flat or barely moving, the difference between the NAV and market price is typically small. But on more volatile days with bigger market swings, the gap almost certainly widens.
For example, if in a single day the market gains or loses 500 points, an ETF’s market price will respond in real time to changing supply and demand. But the ETF won’t recalculate its NAV until the end of the day, after the dust has settled. When that happens, the NAV is generally close to the last market price of the day.
It’s that transparent “intraday” pricing that can make ETFs more attractive vs. mutual funds, which only publish NAVs and have no intraday market prices.
Bid & ask prices
The bid represents the highest real-time price someone is willing to pay for that ETF. The ask is the lowest price someone is willing sell it for. The market price is the midpoint between the bid and ask.
The difference between the bid and the ask is called the bid-ask spread. It’s a cost related to buying and selling ETFs and an even more detailed indicator of current supply and demand than the market price. Other than an ETF’s expense ratio, the bid-ask spread represents another cost that could affect your returns.
The bid-ask spread is also a good measure of liquidity, which refers to an ETF’s ability to quickly and easily be sold for a fair price and converted to cash. Vanguard ETF® spreads, for example, generally range from $0.01 to $0.25, which worked out to around 0.02% of each fund’s price, on average, in 2018.
In particular, our total market ETFs offer some of the smallest bid-ask spreads while helping you create a broadly diversified, low-cost portfolio that covers nearly all aspects of the U.S. and international stock and bond markets.
Trading volume and market volatility are 2 key factors that directly impact the bid-ask spread. Lower trading volume and higher market volatility increase the spread. Higher trading volume and lower market volatility reduce the spread. For example, higher trading volume offers greater chances to buy, sell, and convert an ETF to cash, while lower trading volume presents fewer opportunities.
Understanding premiums & discounts
Start by comparing the last market price of the day with the NAV, which is recalculated at the end of the same day. If the market price is higher than the NAV, it’s called a premium. If it’s lower, it’s a discount.
What’s most important is the magnitude and consistency of those differences. Smaller gaps mean an ETF’s market price isn’t deviating too widely from the value of the underlying stocks or bonds in the ETF. And, if the premium is consistent, you’re more likely to sell at a premium if you bought at a premium.
Better price control
There are several different order types you can use when you’re buying and selling ETFs. Which you choose depends on how much time and attention you want to put into it and whether speed or price is your top priority. You can use these strategies to gain better price control, but experts point to 2 in particular when assessing ETFs:
- Market orders prioritize speed (how quickly your trade is completed) over the specific price you pay or receive for that trade. With a market order, you’ll get the best price available at that moment.
- Limit orders prioritize price over speed. With limit orders, you set the maximum you’re willing to pay when buying shares, or the minimum you’re willing to accept in a sale, giving you the greatest degree of price protection.
Want a happy medium? Try a “marketable” limit order, which leverages the bid or ask price: When buying shares, set your limit at or slightly above the ask price. When selling shares, set the limit at or slightly below the bid price. This combines a degree of price control with a higher likelihood you’ll meet the limits and complete your trade.
ETFs can be buy-and-hold too
A common misconception is that ETFs are best for active day traders—and that buy-and-hold investors should stick with mutual funds. We’re big believers in both types of investments, but this assumption is simply not true.
The abundance of ETF pricing—especially the ability to see market prices change throughout the day—doesn’t mean ETFs are for investors trying to time the markets. ETFs can be just as suitable if you’re a buy-and-hold investor saving for retirement or working toward other long-term goals.
Pricing transparency simply means there’s more information available and that you can complete each trade, whenever you place it, at a better price if you want to put some effort into it. For example, you could look for a tighter bid-ask spread or use a marketable limit order, as we mentioned above—even if your trades are few and far between.