ETFs are unique investment tools; used to formulate various trading strategies for the underlying assets.  ETFs allow investors to participate in a variety of asset classes collectively without increasing risk exposure manifold. Because of its unique features, high liquidity, and low costs, ETFs have earned a niche in the capital market. Let’s find out more about ETFs, and you can diversify your portfolio by including ETFs into it.

What are ETFs?

We can consider an ETF as a basket that holds several securities that often tracks an underlying asset. By nature, it is very similar to mutual funds, but listed with the exchanges and traded in the market like stocks. It is an index fund and follows a benchmark index irrespective of market movement.

An ETF is like a portfolio, containing different types of investments – stocks, commodities, bonds, and more, to create a well-balanced basket. An example of a popular ETF is SPDR S&P 500 ETF (SPY), which tracks the S&P 500 index. ETF funds are highly liquid, and prices of these funds move with the market trends. This allows investors to buy or sell them any time during trading hours.

ETF funds were introduced in India in 2001.  The first ETF was NIFTY BEES (Nifty Benchmark Exchange Traded Scheme) based on NIFTY 50 launched by Benchmark Mutual Funds.

Depending on underlying asset class ETFs are of six types.

  • Gold ETFs– Are a type of commodity ETFs that mainly follow gold as an underlying asset
  • Sector ETFs– The other name of it is Industry ETFs. It tracks a particular industry, such as technology, energy, or finance.
  • Bond ETFs– It includes government bonds, or other typical investment tools that qualify as bonds.
  • Currency ETFs– It allows you to invest in foreign currencies like EURO or Dollar
  • Inverse ETFs– It involves a practice called shorting of stocks, which means selling shares that are expected to fall and repurchasing them at a lower cost.
  • Global Index ETFs It gives investors exposure to both developed and emerging markets to optimise their portfolio.

In developed countries, the ETF market is primarily dominated by institutional investors, but in India, retail investors enjoy the larger market share. The primary distributors of ETFs are the banks, who find it easier to sell open-ended Mutual Funds like funds. If you want to sell or purchase ETFs, you need a DEMAT account, or you can buy from the banks.

ETFs vs Stocks

Stocks are a medium to show ownership interest in a company, whereas ETFs are a collection of investment vehicles that can be traded in the market like stocks.

Stocks give you more control over your investment, but ETFs give you greater market exposure. The commodities featured in ETFs are handpicked by professional experts.

ETFs vs Mutual Funds

Mutual Funds (MFs) and ETFs are similar on many grounds, but there are a few dissimilarities, especially in the ways both are managed.  Here is a crucial difference,

ETFs are traded in the market like stocks throughout the day, but MFs can be purchased at the end of the day based on calculated NAV value. MFs are also actively managed by portfolio managers; on the other hand, ETFs are indirectly managed based on a particular market index.

Besides, ETFs funds charge lower annual fees as compared to traditional mutual funds investment.

ETFs vs Index Funds

ETF funds are a lot like Index Funds. But there are subtle differences; most significantly in the way both are traded. You can exchange ETF funds anytime during trading hours, but Index Funds are purchased or sold only at the beginning or end of a trading day.

ETFs are also more tax-efficient than Index funds. When you sell ETF funds to another buyer, the money comes directly to your account. But in case of Index funds, you need to redeem it, which means capital tax is levied on it.

Are ETFs good investment?

It is a good choice since it allows investors to diversify their portfolios immediately.  Moreover, it is cheaper than Mutual Funds and Index Funds. Plus, it has high liquidity like stocks. Some experts also believe that ETFs make an excellent option for young and new investors, who want to invest in the market without the headache of monitoring trends every time.  But there are a few things to keep in mind while considering it as an investment option.

  • – ETF funds will cost you more than stocks. If you are planning to invest, ask about all the fees in advance
  • – ETFs offer your diversification, but it doesn’t hedge from volatility
  • – Leveraged ETFs experience value decay over time even when an underlying asset shows an uptrend
  • – ETFs offer you less control over taxable income
  • – With ETFs, you have less control over choices of assets
  • – There can be a difference between the price of ETF and the values of underlying assets
  • – Often ETFs are linked to benchmark indexes which means they aren’t allowed to outperform indexes

The Bottom Line

ETF funds are enjoying great popularity as an investment vehicle. These are often preferred for long-term investment. So, if you make an informed choice, there shouldn’t be any reason for you to worry.