How exactly does a broad-market ETF work?

Question

So it's obvious that a broad-market ETF attempts to imitate the performance of the whole stock market, but what I still don't understand is how it works and exactly what you are investing in when you buy a broad market index.

For example, I'm familiar with the VTI ETF, but it currently only costs $131.96. How can such a relatively small amount of money reflect the performance of the entire New York Stock Exchange? Does the Wilshire 5000, which costs approximately $20k, do a better job of imitating general stock market performance?

Answer 1

Suppose that I create an S&P500 ETF today. If I bought 100 shares of all of the component shares at the close, I would have to lay out 5 million dollars. If I issue 50,000 shares, the share cost to you will be $100.

If the aggregate value of the holdings goes up 10% in one month (I'm quite the optimist, eh?), the holdings will be worth 5.5 million dollars and your ETF share will have risen to $110.

Had I issued 100,000 shares, the starting NAV and cost to you would have been $50 and after the rise in share price, each of your shares would be worth $55.

In either case, your investment increased 10% in value while the underlying holdings (the index) increased 10% in value. You participated in the index's rise regardless of the ETF's NAV.

The only question that remains is how come I haven't received your check??? :->)

Answer 2

Imagine two companies - one worth $1 Million that has 10 shares outstanding, and one worth $10 Million that has 10 Million shares outstanding. The shares of the first company will be worth $100,000, each while the shares of the second company will be worth $1. Is the first company 100,000 times "better" than the second?

Prices are not directly comparable across indices, funds, or even individual stocks. What is comparable is returns, or how much the index/equity changes in value.

So buying one "share" of VTI ETF is NOT the same as buying a share of every equity in the market. What you are buying is a share of the assets held by the ETF. ETFs (like companies) can issue as many shares as they see fit. So if the ETF holds 10 Billion dollars in assets, and issues 1 Billion shares, each share will be worth $10. The returns of the ETF are supposed to track the returns of the overall market closely.