How Reverse and Regular ETF Splits Work
Exchange-traded funds( ETFs) are mini-portfolios of stocks that trade like one individual stock, meaning that they are also susceptible to regular splits as well as reverse splits. As an ETF investor, it’s important for you to understand the ETF splitting process and how it impacts your portfolio.
ETF Split Definition
An ETF split is the process of taking the number of outstanding shares and doubling the volume while splitting the price. Typically ETFs splits are two-to-one, but they can occur on different ratios such as three or four to one.
How Does an ETF Split Work?
Say, for example, that an ETF is trading at $100 and has 500,000 outstanding shares. If a two-for-one ETF split is announced, the stock price (barring any news or other market factors), will split to $50, and the number of outstanding shares will double from 500,000 to 1,000,0000.
If you own one share of the ETF, your portfolio is worth $100 ($100 x 1 share). After the split, your new shares will only be worth $50, but you will have 2 shares instead of one. So your portfolio value will remain unchanged, and still be worth $100 ($50 x 2 shares). Again, your overall portfolio value won’t change, but you will have more shares at a lower price.
Splits don’t always occur on a two to one ratio, and sometimes ETFs can split three or four ways. Using the same example, say the split was four-to-one. You would now own 4 shares of the ETF at $25 each, but your total portfolio would still be worth $100 (4 shares x $25).
Why Do ETFs Split?
In most cases, ETFs split to make the price more attractive and reachable for potential investors. If you could buy an ETF for $50 or $100, which would you choose? There are many factors involved–amount of outstanding shares, research, market conditions, and more–but still, if an investor likes a particular fund, it looks more attractive at $50 than $100 and he can buy more shares within his budget at $50 than he can at $100.
Reverse Split Definition
Reverse splits are the opposite of regular ETF splits, but do get a little trickier. Say you own 4 shares of an ETF that is trading at $10. Your total portfolio is worth $40 (4 shares x $10). Then a reverse two-for-one split is announced. So your 4 shares become 2 shares (the reverse of a regular split) and the price of each share goes to $20 (doubling). So your portfolio is still worth $40, you just have fewer shares.
Uneven Reverse ETF Splits
In some cases, the spilt may not be evenly divisible by the amount of shares in your portfolio. So again, referring to the example, if a three-for-one split is announced, three of your shares will go to one and your extra (fourth) share will actually be a “third” of a share after the reverse split. But since you can’t have a third of a share in your account, you will get the cash equivalent of that third.
So staying with the example, you own 4 shares at $10. A three-for-one split is announced. You now own one share at $30 and a third of a share, which is theoretically worth $10 ($30 / 3). But instead of carrying a third of a share, you will just get $10 cash in your portfolio. So your ETF share is worth $30 and you have $10 in cash. Total value = $40 ($10 cash + $30 share). Your total portfolio value is still the same post-reverse split as it was pre-split.
Why Do Reverse Splits Happen?
Typically when the price gets too low for an ETF, the provider may announce a reverse split to bring the price back up to a more “tradable” level. Or the fund may reverse split to make it look more valuable in an investor’s eyes or even avoid going too low and getting delisted. Some ETFs actually have price levels that trigger a reverse split for these very reasons.
A regular or reverse ETF split will not impact the total value of your position, but it will change the amount of shares you own and the trading price. If you have a fund in your portfolio that has announced a split, make sure you understand how it will impact the total value of your positions and your ETF investing strategy.
Also, before making any ETF trades, you may want to look back at the fund history and see if the ETF has ever split or reverse split. And as always, understand the risks of trading an ETF or any asset. Be sure to consult your broker or a financial professional if you have any questions or concerns.