ETF with compound interests and how it works

Question

Suppose I put €1000 in an ETF that doesn't pay dividends. Each day the €1000 will swing based on the earning percentage of the ETF; if on a given day the ETF earning percentage is 10%, my title will be €1100 (i.e. €1000 + 10%).

If I choose to sell that ETF I have earned €100 (for simplicity sake I'm not considering taxes or commissions).

Another option that I have is to hold that title so that compound interests will take place.

The question is: when do these interests come into play? At the end of the year? What is the amount of this interest? Is this the current value of the title * earning percentage in the last day of the year (supposing this is correct)?

Forgive me for the newbie question but I haven't found good response online.

Answer 1

There is no interest (compound or not). The value of the ETF is solely based on it's trading price. If that goes up: you win, if it goes down: you loose. At any given point time the value of your holding is the number of shares times the current share price, regardless of how long you have held the shares.

For ETFs the only thing that's remotely similar to compound interest is "dividend reinvestment". If they are paying dividends you can choose to use the dividends to buy more shares and over time the number of shares goes up.

Answer 2

A savings account has a pre-defined interest earning rate and period (e.g. monthly) and typically pay interest on top of the interest that was earned in prior periods (hence the "compound" interest).

ETFs (and equities in general) do not "compound" in the same way. They do not pay "interest" - their value is based on the value of the underlying stocks (companies) and change continuously (up and down). Since the growth of those companies is typically measured in relative terms (e.g. company x grows by 10% per year), that growth compounds and looks like compound interest (e.g. the stock for x grows at 10% per year). That growth is also continuous (or at least not always at the same time of the year) so the "growth" of the stock is also continuous.

You can see this exponential growth in long-term graphs of large indexes like the S&P 500. It has periods of large ups and downs, but overall it looks just like an exponential (compound) growth curve at a constant rate. Individual companies do not all look that way since they can have much larger ups and downs, but the market overall does tend to look like an exponential growth curve.

Also note that reinvesting dividends is not an example of "compounding". Dividends are just changing equity to cash, so if you reinvest a dividend that is paid, you should have the exact same amount that you did prior to the dividend. For example, if you own one share of a company that is worth $100 per share, and the company pays a $10 dividend, that company is now worth $90 per share (since it's just giving cash to investors), so you now have $90 in stork and $10 in cash. If you reinvest it in the company, you again have $100 of stock in the company.

Answer 3

Suppose I put €1000 in an ETF that doesn't pay dividends.

Faulty assumption.

You buy shares in an ETF. (And it's highly unlikely that you'd invest exactly €1000, since that would require the ETF's share price to be an exact multiple of €10.)

Each day the €1000 will swing based on the earning percentage of the ETF; if on a given day the ETF earning percentage is 10%, my title will be €1100 (i.e. €1000 + 10%).

Since you are an investing newbie, take this question as instructive rather than critical: where did you get that idea? The answer may help clear up any confusion you might have.

An example of how ETF (and mutual fund, and -- in general -- any kind of trading works):

1. buy a set of Magic: The Gathering trading cards for €100.
2. In one year, sell the set. If you sold them for €110, then you've earned €10; if sold them for €80, then you've lost €20.