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What happens to an ETF if an underlying company goes bust?
First Time Investor
So, I’m in the early phases of my investing journey, and trying to bring the better half along for the ride. Unfortunately she has an uncanny knack for asking difficult questions that seem to be hard to google! So the question is this: If a company in which an ETF invests goes belly-up, what happens to the ETF itself? Do you have less actual shares due to the fact that the shares you had in the underlying company no longer exist? Or does the ETF itself just lose the value that those shares represented, but you still have the same number of shares in that ETF? I.e say Company A is 10% of ETF A’s portfolio, and it goes under, do you have 10% less total shares, or the same number of shares but their value has taken a 10% hit? Sorry if it’s a dumb question! Thanks in advance.
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Hi Andrew, solid question!
I’ll tackle it best I can…
— If a company dies, what happens to the ETF?
Very little. That company would be just one of many inside that ETF (say one out of 100, or even 1000+), so in all actuality, it’s barely noticeable even if the company disappeared immediately. In practice though, companies tend to die slowly, and are replaced in the portfolio by other companies which overtake it in size, depending on the ETF’s particular strategy.
— Do you have less shares? No. The shares we own are in the ETF, these stay the same. They may just be slightly less value per share if one company went to zero immediately (since the ETF’s value is based on the collective value of all the companies inside it).
The handy part about diversified investments like ETFs is this exact point – that one company struggling or going under has a minimal effect on the overall investment. And that’s why ETFs (or a portfolio of them) which are more diversified and have more companies are typically safer long term bets.
Hope that helps.
Dave
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