What if no one buys my index at retirement

[RiddleMB]

While being a mustachean for almost 5 years, I'm very new in the stock market, so please excuse in advanced if my question is too basic.
Also, I tried to find a similar existing thread here, but without success.

I'm planning to create a portfolio which consists 100% of VTI. Maybe later I will balance it with VXUS (I live outside the US, so I can only buy ETF).

Today I discovered that in order to buy stocks, somebody needs to be actually selling them!!
The concept of buying and selling something that doesn't even exist quite baffles my simple and straight forward mind. So far I thought that by "buying stocks", I lend my money to companies, and as a token of gratitude, I get their stocks. . .

Anyway, back to my question: this realization made me wonder - in order for me to retire, and live by selling parts of my portfolio each year, I need that someone, probably from the younger generation, see value in those stocks and be willing to buy them from me. What if they won't be interested in index funds? (not talking absolute numbers, but the majority)

I immediately picture some old boomers, trying sell me bits of their individual stocks in order to cover their retirement, which I'm absolutely not interested in buying. Can't the same happen to me down the road with index funds?

Moreover, the usual FIRE strategy is to buy and hold for a couple of decades. Won't it reduce the liquidity of some major, in my case. ETFs such as VT, VTI, VXUS and VOO? (again, some probably will sell a bit as part of balancing a complex portfolio, but the majority if FIRE investors, like me, will hold to theirs)

Obviously I'm not bashing FIRE nor index funds, just want to understand the system before deciding if I should dive into it.

[TheAnonOne]

Quite a few notes here...

Index Funds are just a convenient way to bundle individual shares together. Selling FORD shares directly to the market is basically the same as selling your index to the market that contains FORD (and a few others )

Stocks have intrinsic value. You will never have a time that stocks are high and the index is low, the index OWNS stocks.

Stocks have intrinsic value because they pay dividends, and offer growth. The value is based on that. At some price, someone will buy it.

[TheAnonOne]

As far as liquidity goes, you are right, but index holders also trade pretty often as it is. The market is in a balance, as liquidity goes down, the price will go up causing more people to want to sell and raise liquidity ect ect

The MMM way of thinking isn't new but it certainly is RARELY executed.

[MilesTeg]

While being a mustachean for almost 5 years, I'm very new in the stock market, so please excuse in advanced if my question is too basic.
Also, I tried to find a similar existing thread here, but without success.

I'm planning to create a portfolio which consists 100% of VTI. Maybe later I will balance it with VXUS (I live outside the US, so I can only buy ETF).

Today I discovered that in order to buy stocks, somebody needs to be actually selling them!!
The concept of buying and selling something that doesn't even exist quite baffles my simple and straight forward mind. So far I thought that by "buying stocks", I lend my money to companies, and as a token of gratitude, I get their stocks. . .

Anyway, back to my question: this realization made me wonder - in order for me to retire, and live by selling parts of my portfolio each year, I need that someone, probably from the younger generation, see value in those stocks and be willing to buy them from me. What if they won't be interested in index funds? (not talking absolute numbers, but the majority)

I immediately picture some old boomers, trying sell me bits of their individual stocks in order to cover their retirement, which I'm absolutely not interested in buying. Can't the same happen to me down the road with index funds?

Moreover, the usual FIRE strategy is to buy and hold for a couple of decades. Won't it reduce the liquidity of some major, in my case. ETFs such as VT, VTI, VXUS and VOO? (again, some probably will sell a bit as part of balancing a complex portfolio, but the majority if FIRE investors, like me, will hold to theirs)

Obviously I'm not bashing FIRE nor index funds, just want to understand the system before deciding if I should dive into it.

The very nature of stock (and index) buying/selling means that if a stock is priced at $X/share there is a ready supply of people willing to buy that stock for $X. If there was not people willing to buy, the price would drop.

You might run into a situation with really unpopular stock from some obscure company that might be hard to move, but index funds like VTI own literally the most popular stocks and thus you're really not going to run into that problem.

[DeniseNJ]

You make money on stocks in two ways:

When you buy stocks, you are actually purchasing a small part of a company.  You own it now, or part of it.  Like any business owner, you will make money when your company makes profits--that's what happens you you get dividends.  Basically, that's the profit from your company that isn't being reinvested or otherwise spent.

You can also sell your portion of a company to someone who wants it.  If lots of ppl want it, the price goes up, like a bidding war.  If it's a crappy compnay and few ppl want it, the price goes down.

Index funds are just a small amount of a bunch of different companies that you own with other ppl.  The fund shares are basically worth whatever the stocks in it are worth.  If few ppl wanted your part of the fund, then the price would go down--as with individual stocks.

That's super simple but it's a start.

[Villanelle]

If you are selling stocks and no one is buying, that means the US (assuming US index funds) and in fact the entire world is in a catastrophic meltdown, the likes of which we have never come close to seeing.  At that point, selling index funds is the least of your worries  as you probably need to be foraging for wild plants and learning to make fire to keep warm.

[ILikeDividends]

So far I thought that by "buying stocks", I lend my money to companies, and as a token of gratitude, I get their stocks. . .

This is probably your biggest miss assumption.  When you buy a stock, whether directly or through an index, you are buying an ownership stake in the company.  It is not a loan; your stock is your equity in the company.  Furthermore, if you buy your shares from another investor, the company doesn't get any part of that sale.  The selling investor does; s/he is simply transferring their ownership stake to you for cash today.  You then own a stake in all the future cash flows for as long as you hold the equity.

As long as your equity has value, there will always be someone willing to buy it from you.  It isn't a question of whether they will buy it, it is a question of at what price will they buy it?

Now, if you buy a new-issue bond from a company, that is a loan to the company.  But bonds are a whole different subject with an entirely different risk/reward profile.
 

[BicycleB]

Re "what if no one buys" - that is very unlikely, because ETFs are part of a system in which billions of purchases are made daily. You're not likely to go from billions of transactions to zero.

Billions to half a billion, maybe. That would mean selling your individual shares would take a few seconds, instead of a few tenths of a second.

Also remember:

ETFs are funds. They own actual shares, basically pieces of ownership, in companies. You will never reach a point where all the world's big companies are worth zero. Someone will buy them. Also, the companies make profits and issue those profits as payments called dividends. Your ETF receives these dividends and can, if needed, distribute the dividends to you even if no sale occurs ever. You'll still receive income even if no one ever buys your ETF share. Which in turn means that your ETF share will have value, and at some price, there will be a buyer for it if you choose to sell.

Obviously an individual company can go bankrupt, and the value of a share in it can go to zero. That is rare. In the event of a huge catastrophe, perhaps many companies will temporarily lose money. But the majority of companies won't stay that way. Even in bad times, many companies will survive and soon will be turning a profit.

Here's an explanation of what a share of stock is (link below). This is the first result from my Google search "what is a share of stock". Based on an expensive business degree and 20 years of curious reading, the explanation below is pretty accurate. Of course that means confusingly precise, so remember - at one point in its infancy, a company "issues shares" and receives money for them. That money is used as capital by the company, to set up the business. After that, whoever bought the shares can sell them, and then the new owner can sell them to someone else, who can sell them again. The new owners aren't giving any money to the company, they're just paying each other in order to get the privilege of receiving any dividends (profits) paid out in the future by that share. Sometimes the new owner pays more or less than the last owner, adding a different type of profit (capital gain or loss), just as @DeniseNJ described. None of these transactions affects the company itself, except the original one where the company issued shares.

https://www.investopedia.com/terms/s/stock.asp

Here's an explanation of ETFs in general.

https://en.wikipedia.org/wiki/Exchange-traded_fund

@RiddleMB, is your head exploding yet?   :)

[Christof]

Most ETFs allow you to turn in your share of the ETF and receive the actual shares the fund is holding which means you do not need someone who buys the specific fund, rather the companies, the fund is invested in. The minimum value for this is usually quite high, 125,000€ for most of my ETFs and sometimes there is an extra fee. However, this concept guarantees that someone with money will buy your ETF at a price close to the value of all owned companies, because they can always get those shares instead and sell them individually.

[MustacheAndaHalf]

Really large institutional investors make sure the value of an ETF matches the value of it's underlying stocks.  If the ETF falls too far, these arbitragers buy the ETF, break it up into individual stocks, and sell those stocks.  They profit off the difference - which is why those differences are usually very tiny.

Would you buy Apple for $5?  The entire company - their land, factories, IP, ...?  That's why the S&P 500 won't hit $100 in value... someone would buy it long before then.  When you try to sell stocks, the question isn't "if" someone will buy, but "at what price" someone will buy.  Holding 100% of a company's stock means you own the company.  That helps keep large, visible companies (like the S&P 500 companies) above the value of their assets.

[MDM]

See VTI Profile: Vanguard Total Stock Market ETF - NASDAQ.com for some numbers.  E.g., on average 2.5 million shares of VTI are bought and sold every day.  At current value, that's about $375 million worth of VTI being bought and sold every single day.

Unless you expect to own a very large fraction of that $375 million, selling whenever you want shouldn't be a problem. :)

[BTDretire]

Just a bit more info, VTI is a basket that holds the stock of 3,637 different companies. (6-30-19)
 As people buy and sell each one of these 3,637 companies it affects the value of the VTI basket.
 I'm a little unclear as to how the second by second price is determined, I think it's demand/supply for VTI,
 but as said before, if it gets far* from the price of the underlying 3,637 stocks in the basket, the market corrects that rather quickly.

*I wonder what far means, is it a penny or less?

[dougules]

Instead of old retirees or other investors, it may be the companies themselves that buy the stock back from you.  So many companies have a firehose of earnings coming in.  Buybacks have become a popular way for them to give that cash to the stockholders that want it right now. 

[ctuser1]

OP,

You ARE relying on two things when you invest in VTI:
1. Vanguard’s ability to maintain the basket backing VTI and track closely to SP500, a complicated task that vanguard has done remarkably well so far.
2. Market liquidity of VTI and its constituents.

If any of these break down, your ability to sell VTI suffers. The degree of loss depends on the degree of breakdown.

Loooong time ago, I used to work at a hedge fund where the most successful commodity trader made a career out of exploiting arbitrage opportunities in the US electricity markets due to #1and #2.

When you buy electricity at ‘PJM East’ on NYMEX (GLOBEX now) you are really buying a basket of individual electricity contracts in hundreds of electricity pricing points. They are not liquid. So as a trader, you can make hay bleeding the utility companies who have to buy/sell to balance their books.

If you need to sell VTI at such time of market disruption due to liquidity issue, most probably the HFTs will bleed you dry.

Bottom line, you need efficient and liquid marketplace for all of our investment thesis to actually work out.

US markets have been both efficient and liquid for a long time. Let’s hope they continue to be for a longer time yet. If that changes then you’d likely have much bigger problems than selling VTI!!

[MustacheAndaHalf]

1. Vanguard’s ability to maintain the basket backing VTI and track closely to SP500, a complicated task that vanguard has done remarkably well so far.

Did you know Vanguard actually shifts that responsibility onto other companies?

Vanguard authorizes large institutions to transact "creation units" of VTI.  I don't know the specifics for VTI, but often creation units are 1 million shares (about $150 million worth of Vanguard Total Stock Market ETF).  You can view data about this difference at the bottom of the "Performance" tab on Vanguard's website:
https://investor.vanguard.com/etf/profile/performance/vti

According to their data, the difference between market value ("NAV") and market price is almost always less than 0.25%.  When it's worth too much, a large institution buys $150 million of the underlying stocks, and then forms a creation unit of 1 million shares of VTI.  Since the underlying shares were cheaper than VTI, when they sell 1 million new shares on the market they make a profit.  Vanguard has to approve these large institutions in advance, and form an agreement.  After that, it's the profit motive of large institutions keeping the NAV ("net asset value") of ETF shares close to their market price.

[shinn497]

Of all the things you can buy or sell, stocks, and other securities, are sold at the highest volume, and have the longest track record of increasing in price. So don't worry. If it comes to pass that the stock market isn't the best way of achieving value long term, then you will have other worries than your retirement, since it means society is crumbling.

FWIW, societies have crumbled, and the stock market has persisted. China and Russia experienced stock markets that have gone to zero

[dougules]

Of all the things you can buy or sell, stocks, and other securities, are sold at the highest volume, and have the longest track record of increasing in price. So don't worry. If it comes to pass that the stock market isn't the best way of achieving value long term, then you will have other worries than your retirement, since it means society is crumbling.

FWIW, societies have crumbled, and the stock market has persisted. China and Russia experienced stock markets that have gone to zero

In the event that some major event takes the stock market down along with the whole economy, practicing skills that help you to be frugal and self-sufficient will be the best investment you could have made. 

[BTDretire]

OP,

You ARE relying on two things when you invest in VTI:
1. Vanguard’s ability to maintain the basket backing VTI and track closely to SP500, a complicated task that vanguard has done remarkably well so far.

Just a correction, VTI is the ETF of VTSAX, which is the 'Vanguard Total Stock Market Fund'. It holds the stock of about 3,637 stocks.

[RiddleMB]

I agree with all that you said. Of course the value of index funds will go down in a visible way if people will stop buying it, which probably won't happen as long as it contains profitable companies in it.

Maybe the problem is that I had lived in two countries (USSR and Middle-East) in which the concept of the stock market is little known.
If I wasn't planning on retiring early, I wouldn't even know the concept of an "index fund" and I would have stayed away from stock market and individual stocks like fire (the exothermic process, not the movement).

In my mind, there is no reason to buy index funds, unless the person is planning on retiring early, thus my assumption that the next generation, to whom I will be selling my funds, need to want the same. Maybe you, mostly Americans, look at it in a different way.

[BTDretire]

In my mind, there is no reason to buy index funds, unless the person is planning on retiring early, thus my assumption that the next generation, to whom I will be selling my funds, need to want the same. Maybe you, mostly Americans, look at it in a different way.

  I don't understand your last statement.
Does it mean if not retiring early there's no reason to save?
Does it mean you would invest in something other than stocks?
 What point were you making?

[ctuser1]

OP,

Functioning markets are a proxy of functioning society, which in turn rely on whether the participants in the market/society "trust" that the market/society will continue to function.

I like to hope for the best and prepare for the worst.

Learning to live frugally (i.e. relying on as little material needs as possible) is the best possible "prepare for the worst" strategy I can think of. When SHTF happens - carnivorous dinosaurs (i.e. the guns and ammo peppers) die and the scurrilous rodents (i.e. people who need little and can duck and take cover, back to the land prepares and the like) has a much higher probability to survive. This is not theory! SHTF has happened in many places and times in world history and there have been detailed economic/historical studies involving some of them that can be studied. Being frugal and mustachios, learning to understand what real "needs" are etc are all very good practical preparations for the "worst".

However, "prepare for the worst" is only one half of the picture. It is very likely that the good run the world has had in the last 500 years - almost uninterrupted, if gradual, improvement in the living standards of the humanity in general - is going to continue. How do you cover your bases in this likely (I'd guess 99+% possibility) case? Well, you invest in VTI..

I think it is short sighted to completely ignore the possibility of the 1% event, but it is way beyond short-sighted to not prepare for the 99% probability event.

On another note, thanks for fixing my mistake on VT. Yes, it is a total market index, not an SP500 one. VTI is the SP500 index.


 

[RiddleMB]

Does it mean if not retiring early there's no reason to save?

No, a person always needs to save, regardless to his/her plans.

Does it mean you would invest in something other than stocks?

Yes. If I didn't plan to retire early, I would probably, like the rest of the people I live among, buy an apartment for living. There is nothing else to do with money in those parts of the world. Many years ago, I rememer people did "short-term deposit" in their banks, but that as far as investing goes if not to take active stock trading into account.

I'm trying to figure out if people in US / Europe looks at stocks differently.

S.P I'm starting to suspct that people put only part of their money into buying index funds, while having the rest invested in real estates or other things unavailable here. For me to get enough for retirement means investing all the money I accumulated and all future salaries in ETF.

[ctuser1]

I would probably, like the rest of the people I live among, buy an apartment for living. There is nothing else to do with money in those parts of the world. Many years ago, I rememer people did "short-term deposit" in their banks, but that as far as investing goes if not to take active stock trading into account.

I'm trying to figure out if people in US / Europe looks at stocks differently.

S.P I'm starting to suspct that people put only part of their money into buying index funds, while having the rest invested in real estates or other things unavailable here. For me to get enough for retirement means investing all the money I accumulated and all future salaries in ETF.

I'm not sure I fully understand your logic here. However, real estate investment is among the worst possible risk hedge to protect against the kind of societal breakdown that you imply (via your distrust of "index funds").
Note: this applies to real estate purchased as "investment" - not for living. The place you live in is not an investment!!

VT/VTI, in my opinion, is a far superior disaster hedge compared to any real estate in europe.

Consider a "mild" disaster - the Argentinian economic collapse. Now consider an Argentinian investor invested in SP500 vs. one the bought rental apartments in Buenos Aires. Who do you think would have fared better??

This breaks down only when the complete world economy breaks down, which is obviously possible - but your real estate holding is not going to protect you in that case. Property rights is the first thing to go in a total breakdown. Without property rights - RE holding where you don't live in (and hence can physically defend) is worthless!!

I don't have any direct experience with any economic disasters. However, I have in-law relatives who have lost all their real-estate holdings in such a disaster and went from very wealthy to penniless. So I *know* to avoid RE investment as a risk hedge.

[insufFIcientfunds]

There are times when companies on the stock market get delisted (aka kicked out.)

https://www.asicentral.com/magazines/counselor/news/content.aspx?id=1864

Index funds are hedged against those kinds of downturns if not for the simple fact they are invested in such a large number of companies.

If you are looking to invest in individual companies, there may be a chance that it's delisted and you can't sell, or the stock tanks, or whatever. A little common sense would tell a person...this company blows/has an antiquated business model/sells crappy products, etc. to stay away.

AT&T stock doesn't fall into that category. They don't blow (that much.)

[MustacheAndaHalf]

...
On another note, thanks for fixing my mistake on VT. Yes, it is a total market index, not an SP500 one. VTI is the SP500 index.

You can search for "VTI" online, or look for "vanguard ETFs" to get the list.  But that's not an S&P 500 ETF.

VT : Vanguard Total World ETF
VTI : Vanguard Total Stock Market ETF
VOO : Vanguard S&P 500 ETF

[ctuser1]

...
On another note, thanks for fixing my mistake on VT. Yes, it is a total market index, not an SP500 one. VTI is the SP500 index.

You can search for "VTI" online, or look for "vanguard ETFs" to get the list.  But that's not an S&P 500 ETF.

VT : Vanguard Total World ETF
VTI : Vanguard Total Stock Market ETF
VOO : Vanguard S&P 500 ETF

Thx.

Off topic - but this actually has practical implications for me.

I am teaching my older kid about investing. She has a UTMA account. She earns small amounts of money for doing chores and figuring out other ways of saving/earning small amounts of money (e.g. ebaying an old phone, prize money from a school-level competition, bottle deposit etc. etc. etc.). I suggested her to invest in VT/VTI thinking VTI is the SP500 component. :-(

I guess I was just being lazy!!

I like being in SP500 more than the US total market for the next 20-30 years because I believe tech trends will result in profit-concentration towards the larger cap organizations and that smaller competitors will not be able to keep up.

I will tell her to go for VOO next time she saves up $300.

[Radagast]

You are also forgetting fundamentals. Let's say right now VT (Vanguard Total World Stock) yields 2.5%. Over the next two years people around the world become very uninterested in buying stocks, and stocks lose 50% of their value, and then 50% again. This can happen in any market, from tomatoes to houses, when people suddenly lose interest in buying. Your dividend doubled! And doubled again! You now get 10% dividend. Do the math. After 20 years, you will have more money than you would have had people maintained enthusiasm and 2.5% dividends at a constant rate, because you will now be compounding at 10% annually instead of 2.5%. At 30 years you will have twice as much as you would have. In real life shareholders may also vote to increase dividends or stock buybacks if there is a lack of enthusiasm from would-be-owners. We (collectively) own the companies, we can (collectively) tell them what to do.

That is why people say stocks will be safe after 20-30 years, because dividend compounding ensures they will (barring a catastrophic war, communist takeover, or other total collapse which would also wipe out bonds and even perhaps income real estate). But you will be in a hard spot at first. You should have at least a few years living expenses in safe bonds to give people time to realize their error and start buying again. You probably should also take the chance to load up on VT while its dividend is 10%. This also illustrates why I also recommend people have a lot of bonds (about 25%, +/- 15%) when they go from FI to RE.

[vand]

There will always be a buyer. That is how the pricing mechanism works to find a market clearing equilibrium between buyers and sellers.

If buyers can't be found then the price will fall until buyers are found.

[jim555]

If you had 100,000 shares (1 creation unit) of VTI you could demand the actual shares from the fund.

[JohnnyZ]

Maybe the problem is that I had lived in two countries (USSR and Middle-East) in which the concept of the stock market is little known.
If I wasn't planning on retiring early, I wouldn't even know the concept of an "index fund" and I would have stayed away from stock market and individual stocks like fire (the exothermic process, not the movement).

I'm the same, I'm European and until recently I didn't know about ETFs and my idea of the stock market was Wall Street hot shots screaming buy- and sell-orders of individual stocks (really, the Hollywood version), and since I thought I would never know what to buy or when to sell I wanted no part of it. I would suspect the average Joe USA is more educated about the stock market than people from other countries are (that's probably related to my next point).

  I don't understand your last statement.
Does it mean if not retiring early there's no reason to save?
Does it mean you would invest in something other than stocks?
 What point were you making?

Don't know if that applies to OP's case, but in my country money is taken from every paycheck for the national pension scheme. Then, when you reach the age of X and have worked for Y years, the scheme gives you a monthly payment of Z% of your previous income (that's putting it simply as there are different systems, but you get the idea). Of course people still have an emergency fund or save more if Z% is not going to be enough to live on, but there's no one saying "I need 2 millions to retire".

[MustacheAndaHalf]

If you had 100,000 shares (1 creation unit) of VTI you could demand the actual shares from the fund.

I see that in the SAI (Statement of Adiditional Information) for the fund: 100,000 shares are a creation unit ($15 million worth).

Having a creation unit does not entitle you to transact with the fund directly.  To quote page 25 of the SAI for VTI:
"ETF Shares of the Fund cannot be directly purchased from or redeemed with the Fund, except by certain authorized broker-dealers."

[Christof]

Does it mean if not retiring early there's no reason to save?

No, a person always needs to save, regardless to his/her plans.

Does it mean you would invest in something other than stocks?

Yes. If I didn't plan to retire early, I would probably, like the rest of the people I live among, buy an apartment for living. There is nothing else to do with money in those parts of the world. Many years ago, I rememer people did "short-term deposit" in their banks, but that as far as investing goes if not to take active stock trading into account.

I'm trying to figure out if people in US / Europe looks at stocks differently.

S.P I'm starting to suspct that people put only part of their money into buying index funds, while having the rest invested in real estates or other things unavailable here. For me to get enough for retirement means investing all the money I accumulated and all future salaries in ETF.

There is one thing you are missing. Neither Vanguard funds nor the companies that are in the fund are limited to your country. Even if people are not trading them in your country they are trading them somewhere else generating arbitrage for someone in your country. You can sell your stock everywhere it just is more difficult to handle taxation and the like.

[flipboard]

I'm the same, I'm European and until recently I didn't know about ETFs and my idea of the stock market was Wall Street hot shots screaming buy- and sell-orders of individual stocks (really, the Hollywood version), and since I thought I would never know what to buy or when to sell I wanted no part of it. I would suspect the average Joe USA is more educated about the stock market than people from other countries are (that's probably related to my next point).

I can assure you, the average "Joe" is not any more informed than the average Jonas/Jose/Jakub/Jin.

Functioning retirement systems in many countries mean that most people don't have to figure out stock markets, whereas the shift to 401k's in the US means that americans have to interact with the market more, but that doesn't mean that people actually have any idea of how things work. But something like 35% of americans don't even have access to workplace retirement plans.

And once you get to high net worth people, they invest in stocks worldwide - mostly because their banks and financial advisors push them that way, and not because they actually have any clue.

[Sibley]

OP, there's a lot of words on this thread. I have a really simple response: you fundamentally do not understand how this works.

Go read J Collin's stock series.

[RiddleMB]

Go read J Collin's stock series.

I read it. And re-read it.
In fact, I have it in my bookmarks and I frequently re-read selected posts from there.
I even discovered The Wealthy Accountant through Jim's latest footnotes in "Investing in raging bull".

I would like to be wrong, but so far I failed to find answers for my points of concern. . .
MMM wrote in one of his posts: "investment is something that generates you money by merely owning it, even if you won't be able to sell it"
Index fund doesn't fit this description. The dividends are low, thus most of the money suppose to come at the time of selling.

Now, as far as I know, people who buy index funds, as opposed to individual stocks, are people who don't care for supporting companies, nor about having come control over it, nor the fact that these are successful companies which grow and improve.

People who buy index funds are interested in making extra money from the stocks price, and for that to happen, the next person who buys it from them should be equally interested in those stocks (he will hold them as well for about 30 years and plan on selling them for a high price).  Now, what if there won't be such a buyer?

With the same success, I can buy 10 Custom Shop Gibson guitars, hold them for 30 years, and hope their value will sky rocket and be in demand, but I think that most people here will tell me it is a bad investment of my money.

Please feel free to correct me where I am wrong :)

[ctuser1]

The dividends are low, thus most of the money suppose to come at the time of selling.

Incorrect!!

Go to http://www.moneychimp.com/features/market_cagr.htm
- Adjust for Inflation.

CAGR from 1871 to 2018, including dividends, is 6.87%
CAGR from 1871 to 2018, excluding dividends, is 2.28%

More than two-thirds of the real return come from the puny looking dividends!! Compounding math does not work in intuitive ways!!

There are additional levels of complication that I obviously avoided:
1. Index funds often avoid passing on the dividends. Mathematically that is irrelevant for your return expectations.
2. Dividends were typically higher 100 years ago than they are now. The point still stands that the "tiny" dividends are still significant in the long run.

[ctuser1]

The concept I think you are really angling for is the "Intrinsic Value". This is a number that - in theory - represents the present day value of ALL expected future cashflows coming to you from the company.

What are those expected future cashflows:
1. Dividends.
2. Stock buyback, indirectly boosts dividends.
3. Disbursement when the company is liquidated, hopefully never so that it can continue paying dividends forever.

So your return expectations come from either dividends, or expected future increase in dividends.

Do this for all components for the index fund and you will have the intrinsic value of the Index fund!!

[Incandenza]

Your emphasis on "finding a buyer" for your index fund suggests that you don't really understand how index funds, or the stock market in general, works.  As has been explained, an index fund is a fund constructed to match or track an index, like say the S&P 500.  Nobody "buys your index fund." People buy and sell stock or stocks on the index, which rises and falls as a result.  The value of your index fund rises and falls in line with the value of the index. So the problem you're identifying is not that "nobody will buy my index," it's just that the index itself will decline.

While an index like the S&P 500 declining over a 30 year period is theoretically possible, it's extremely unlikely given historical precedent. Hence your decision not to buy and hold stocks over the long run isn't particularly sensible or based in fact or logic. 

[ctuser1]

I don't quite see RiddleMB's opinions, personally, as stemming from "not understanding".

Being able to question from basics is useful. It does not have to be an end of the world scenario for VTI to suddenly become illiquid (i.e. no buyers to be found).

What happens if Vanguard default - there is counterparty risk, right? (answer: orderly liquidation of assets where you will be made almost whole, after a few years of courtroom drama)

What happens if Vanguard someday pull an accounting scandal of the scale of Anderson/WorldCom/Enron etc? (answer: This is far more difficult to predict. Some form of liquidation will happen, may not be orderly).

The only point I would like to make to RiddleMB is that these risk scenarios he raises are not impossible, just that they are implausible and any other risk he is going to take in any other form of investing would be far higher!!

[Villanelle]

The thing about your Gibson guitars is that first, that is all your money in one item.  If Gibsons go up immensely in value, you are set.  If the don't you are screwed.  In that sense, it is more comparable to putting all your retirement money in one stock, not a mutual fund.  Second, you have to go out and find a buyer personally.  With index funds, that is all done for you.  Third, if there is a fire or theft, your guitars are gone (barring insurance, which you of course have to pay for and eats in to your eventual profit). Fourth, look that the number of Gibson guitars sold around the world in any given hour, then look at the number of shares of index funds (or even one specific, broad, large index fund).  That volume is what essentially guarantees you a buyer nearly the instant you want to sell. 

The question is not whether you will be able to sell, but for how much. 

If broad index funds are no longer being commonly traded, that means the entire world financial order probably has collapsed*.  If 10 Gibson guitars don't sell, it means that maybe someone has produced a better guitar, or perhaps the market is just overly saturated and everyone (of the very small people who want and can afford a Gibson) who wants one has one. 

There are a few other, incredibly unlikely scenarios where it might happen, most of which would still give you some recourse and eventually some money. 

[DeniseNJ]

The concept I think you are really angling for is the "Intrinsic Value". This is a number that - in theory - represents the present day value of ALL expected future cashflows coming to you from the company.

What are those expected future cashflows:
1. Dividends.
2. Stock buyback, indirectly boosts dividends.
3. Disbursement when the company is liquidated, hopefully never so that it can continue paying dividends forever.

So your return expectations come from either dividends, or expected future increase in dividends.

Do this for all components for the index fund and you will have the intrinsic value of the Index fund!!

This.  You do make money from owning stock while you own it.  You are part owner of a company--or hundreds of companies.  There's a chance no one will want your ATT stock, the price will plummet, they go bankrupt, and you can't give them away, since owning a company that doesn't exist is not worth the paper it's printed on.

With owning a bunch of comanies, the ones that go bankrupt and out of business drop out of the portfolio, while the ones that make tons of profit, make up the difference so that your share keeps making you money, therefore keeps being worth something.  Then you sell, hopefully for more than you bought it.

But yes, over time the real money is made when you sell--and if you've reinvested your dividends then your money grows exponentially.

[RiddleMB]

Thanks for the answers! I really appreciate your help!

Ok, I understand how my "Gibson guitars" example doesn't fit the index fund.

Nobody "buys your index fund." People buy and sell stock or stocks on the index, which rises and falls as a result.

So if I understand correctly, the price of an ETF, VTI or VOO, for example (because one of these I'm planning to buy), is determined partly by the success of the individual stocks inside it, in addition to the demand on the ETF itself.

But then I wonder: if I want to buy/sell shares of an ETF, I go to the "Ask" or "Bid" and send a request with a price on the ETF itself, not the accumulation of the stocks inside it.
This last line is what heavily contradicts my understanding of "ETFs are valued according to the value of the individual stocks it holds"
Can anyone elaborate on it?

[Grog]

Market makers (Google it) are institutions that make sure that you will always be able to sell your etf. Is their job. I was trading a very illiquid etf (it was a new one on the Swiss market) and I could always buy and sell, but I was interacting with a market maker, not another investor.
The more illiquid of course the higher the spread

Sent from my Hisense A2T using Tapatalk

[MustacheAndaHalf]

First it's important to see if you can invest in your country.  It looks like "Interactive Brokers" can handle business in several Middle Eastern countries (Saudi Arabia, Oman, United Arab Emirates ... but not Iran or Iraq).
https://www.interactivebrokers.com/en/index.php?f=7021

Individual countries have suffered stock market collapse.  But thus far, the world has not.  So if you diversify to Vanguard Total World ETF (VT), you'll have thousands of stocks representing countries around the world.  You can also buy an ETF at any brokerage - you don't need Vanguard in your country.

Individual countries have had their stock markets go to zero.  But if you diversify by purchasing the 6,000 largest companies from around the world - when has that happened?  A situation that dire would probably require food and ammo.

The stock doesn't know you own it.  So if you buy just 1 company's stock, or thousands, you'll have the same impact on the stock.  You won't have a seat in the boardroom.  Concentrating your stock doesn't mean you can alter the outcome for that company.  Individual company's have a risk of that company collapsing.  But it's much less likely that all company's collapse (let alone stop growing).

The worldwide stock market has beaten bonds, cash, and gold for decades.  If you demand certainty, and just buy a house or save up cash, you will lose out on the strong probability that stocks will outperform either of those choices.

[jim555]

Thanks for the answers! I really appreciate your help!

Ok, I understand how my "Gibson guitars" example doesn't fit the index fund.

Nobody "buys your index fund." People buy and sell stock or stocks on the index, which rises and falls as a result.

So if I understand correctly, the price of an ETF, VTI or VOO, for example (because one of these I'm planning to buy), is determined partly by the success of the individual stocks inside it, in addition to the demand on the ETF itself.

But then I wonder: if I want to buy/sell shares of an ETF, I go to the "Ask" or "Bid" and send a request with a price on the ETF itself, not the accumulation of the stocks inside it.
This last line is what heavily contradicts my understanding of "ETFs are valued according to the value of the individual stocks it holds"
Can anyone elaborate on it?

ETFs are traded at prices agreed to by buyer and seller.  That price may diverge from the underlying net asset value of the shares in the ETF.  If the divergence is large enough large players will arbitrage the difference by buying or selling a basket of shares that make up the ETF and demanding delivery or delivering the shares into the ETF.  That is why creation units are part of the ETF structure, to keep ETF prices aligned with the actual underlying share prices  in the ETF.

[ctuser1]

Nobody "buys your index fund." People buy and sell stock or stocks on the index, which rises and falls as a result.

So if I understand correctly, the price of an ETF, VTI or VOO, for example (because one of these I'm planning to buy), is determined partly by the success of the individual stocks inside it, in addition to the demand on the ETF itself.
....

When you use the word "partly", I am afraid you are not completely appreciative of how strong the dependency is!!

Example: VOO.
Markets are closed in the US now. i.e. the security is *very* illiquid (in the after/before markets) compared to usual periods when your orders by any broker will typically be executed in the regular market.

Last Px: $266.88. Mid Px: $265.775. Bid ask spread right now is: $0.09.
i.e. bid-ask spread = 0.034% of the Mid Px.

Mid Px is a very good approximation of the NPV (i.e. average of the underlying stock prices). This *can* sometimes break down, but is extremely rare in liquid securities like VOO.
Bid Ask spread represents the market inefficiency/illiquidity.

The point of pulling these numbers is that even in the *very illiquid* after/before market, VOO is tracking its intrinsic value with a tracking error < 0.034%/2 = 0.017%.

I don't know about you, to me that is not "partial" dependence - but something closer to a "total and complete" dependence. It is not "mathematical" dependence, but nothing in real world is, and hence that is irrelevant for any real world discussion.

How that almost "total and complete dependence" is maintained is a rather complicated topic involving many actors (specialists and market makers and exchanges and depositories etc. etc. etc.). I don't 100% know how VOO etc work, but if I were to generalize my knowledge writing code for some commodity etfs - then the mechanism is (in very broad strokes):
1. There are underwriters of these etfs, who are on the hook to make up the difference if the intrinsic value and market price diverges AND market participants demand delivery based on the underlying basket. These underwriters have to prove to SEC and other entities they have sufficient financial solvency to take this role, AND maintain sufficient liquidity.
2. Depending on which exchange these ETFs trade on, there will be another set of powerful players called market makers or specialists who will be incentivized to make sure the ETFs are liquid and track closely to the intrinsic value. On each trade, this group make money = Bid-Ask spread. As volume of trade increases, bid-ask spread decreases, netting roughly stable reward for this group to maintain market liquidity.
3. There are horde of traders whose sole job is to arbitrage the ETF market to take advantage of any tracking error. Essentially, if the groups #1 and #2 fail, people in $3 take advantage of it.

Bottomline - for something like VOO/VTI - the price is almost totally dependent on the basket's intrinsic value. Any divergence is almost negligible.

You *are* depending on a lot of actors to do their jobs to maintain this state of affairs when you buy them for retirement!! But this dependency is a lot less (I'd say orders of magnitude less) than if you buy Gibson Guitars, or real estate, or gold - for example!!

[BicycleB]

So if I understand correctly, the price of an ETF, VTI or VOO, for example (because one of these I'm planning to buy), is determined partly by the success of the individual stocks inside it, in addition to the demand on the ETF itself.

The price is determined almost entirely by the success of the individual stocks inside it.

But then I wonder: if I want to buy/sell shares of an ETF, I go to the "Ask" or "Bid" and send a request with a price on the ETF itself, not the accumulation of the stocks inside it.

True.

This last line is what heavily contradicts my understanding of "ETFs are valued according to the value of the individual stocks it holds"
Can anyone elaborate on it?

There are a bunch of details behind it which have the effect that the ETF price will persistently come within a fraction of a percent of the value of the individual stocks it holds.

Broad strokes of these details: ETFs are a complex product created through a set of contractual agreements between various companies in the financial industry. These contracts make it clear that the ETF is worth almost exactly the value of the stocks inside it, essentially by specifying procedures for creating and liquidating the ETF that make it obvious that a share of the ETF holds an almost exactly equivalent value to the value of the of the stocks it holds. In the event of a huge collapse of the global securities industry, the contracts specify that the ETFs will be handled in ways that make it almost certain that the ETF price will still be within a fraction of a percent of the price of the individual stocks it holds. Even if the ETF company itself goes bankrupt, the ETF is an asset of the company that will be sold through the bankruptcy process to some other company, which will fulfill the contracts that create and maintain the ETF.  The contracts also basically state that if the ETF can't stay within a fraction of a percent, the ETF company will liquidate the ETF and either give you the shares or sell the shares and give you the money. So you STILL would get the value of the individual stocks it holds.

[MustacheAndaHalf]

So if I understand correctly, the price of an ETF, VTI or VOO, for example (because one of these I'm planning to buy), is determined partly by the success of the individual stocks inside it, in addition to the demand on the ETF itself.

The price is determined almost entirely by the success of the individual stocks inside it.

True, it's very tiny.  In case OP needs some additional information to back that up, there's the concept of NAV (net asset value).  NAV is the price of the stocks in the ETF, while "Price" refers to the change to NAV based on supply/demand.  If you look at the data Vanguard provides for VTI, it's very slight: 0% to 0.25% range (see the last entry on the page, about discount/premium).
https://investor.vanguard.com/etf/profile/performance/vti

You can also view the price and NAV of VTI on the main page.  After all the market churn in the market, the price is $144.80 and the NAV is $144.84.  That $0.04 difference represents a 0.03% discount from the value of the assets.  Someone buys $10,000 in the ETF and holds $10,003 worth of stock.  That's the level of difference involved.

You can also visit the portfolio details page of VTI, where you'll see it has over $100 billion in assets.  Combined with other classes of the fund, Vanguard holds 0.8 trillion dollars in total stock market funds and this ETF.  I don't know which Middle Eastern country you're in now, but that's more than the GDP of your country.  Turkey and Saudi Arabia both have smaller GDPs than Vanguard has total stock market assets.

  Vanguard overall holds over $800 billion in total stock market funds of all classes (ETF, Admiral, Institutional):
https://investor.vanguard.com/etf/profile/portfolio/vti

[RiddleMB]

Awesome answers, thanks everyone!

The NAV makes sense to me. I guess I can open an investment account and buy ETF without worries.

Just last question: what me from selling an ETF for a higher price than its NAV, thus speculating the price? Apart from the fact that nobody will buy it from me.

[habanero]

Just last question: what me from selling an ETF for a higher price than its NAV, thus speculating the price? Apart from the fact that nobody will buy it from me.

Nothing, apart from the fact that noone will buy if from you. The big US-based ETFs have, from your point of view, infinite liquidity at very tight prices so it will only trade at or extremely close to its actual value. If you stick in a sell order at a higher price it won't get match until the market actually moves until it's the correct price and the trade will go through. If the market goes the other way your sell order will never be executed.