In the last few years, there has been a huge interest among investors regarding Exchange Traded Funds, also popularly known as ETFs.
ETFs were first introduced in 1989 by the American Stock Exchange and the Philadelphia Stock Exchange. But it took more than a decade for ETFs to enter the Indian stock markets.
This article will help you to understand and make the best decision regarding ETFs.
In this article you will learn:
- What are Exchange Traded Funds?
- Types of Exchange Traded Funds
- Advantages of Exchange Traded Funds
- Disadvantages of Exchange Traded Funds
What are Exchange Traded Funds?
An Exchange Traded Funds is a basket of securities that helps investors to track the performance of a select benchmark index. Some of the common benchmark indices include the BSE Sensex, Nifty 50, S&P BSE Banks, etc.
ETFs are not like your regular mutual funds. Unlike mutual funds, ETFs can be traded on the stock exchange in real-time. This means you can buy ETFs in the morning and sell them during trading hours to get the benefits of intraday trading.
With ETFs, you can enjoy the benefits of mutual funds and at the same time, you can enjoy it as a regular stock that can be easily traded in the stock market.
Let's understand it with an example:
You want to invest in BSE Sensex which consists of 30 stocks. Now normally you will have two options -
● Buy each stock that makes up the BSE Sensex index separately. But this means you have to invest a huge amount.
● The other option is to invest in an index mutual fund. But you cannot trade units of index mutual funds.
The middle route for both of these options is to invest in an ETF. This way you save up on money and can trade ETFs like stocks.
An ETF pools money from various different investors just like mutual funds and investors are allotted units. In this case, units are listed in the stock market and the NAV of ETFs keeps on changing as per the market ups and downs. ETFs do not try to outperform the corresponding index. They just aim to mirror the performance of the index.
Types of Exchange Traded Funds
1. Equity ETFs: It is a basket of equity stocks. This is further subdivided as per the sector it monitors.
2. Debt ETFs: It is a basket containing fixed income instruments like government bonds, corporate bonds, treasury bills, etc. For example - Bharat Bond ETFs
3. Commodity ETFs: Commodity ETFs like gold ETFs allows you to participate in the price movements of gold without holding physical gold. The Securities and Exchange Board of India (SEBI) has also approved the establishment of silver exchange traded funds by mutual fund houses.
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Advantages of Exchange Traded Funds
1. Low investment cost: Most of the ETFs are passively managed. This means investors do not have to pay fund manager fees. This leads to lower expense ratio and automatically increases the overall returns in the hands of the investor.
2. Diversification: ETFs give their investors a chance to diversify their portfolio across different industries, sectors, and styles. They also help you gain superior diversification as the losses in a few stocks are offset by gains in the other stocks.
3. Transparent: When it comes to ETFs, their transparency is remarkable. You will find the stocks in which the ETFs have been invested easily from any domain as it is mandated by SEBI. They disclose their holdings monthly and NAV is disclosed daily.
4. Liquidity: The best part of ETFs is that they can be traded in the stock market during market hours. In mutual funds, the NAV is disclosed at the end of the day. But in ETFs, you can actually buy and sell on real-time basis.
Disadvantages of Exchange Traded Funds
1. Misuse of investment period: Investment in a mutual fund is done with a long term aim. But with ETFs, traders can buy and sell their units throughout the day. This continuous buying and selling ruins the investors’ mind set and also hampers the power of compounding.
2. Brokerage commission: ETFs are just like buying shares from the market which results in investors having to pay brokerage and tax every time they buy and sell the shares. The more the buying and selling that takes place, the more the tax and brokerage investors have to pay.
3. Trading Volume: With the exception of a few well-known ETFs, most ETFs in India have very modest trading volumes.
These were all the important points you must know about Exchange Traded Funds before you start investing in one.
Hope this article was useful.
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