Okay, so you want to invest in stocks, currencies, commodities, or money markets, but you don’t have the right knowledge nor the time to do all the research that is required before investing in these assets, or you are just looking to diversify your portfolio, then, ETFs might be for you.

In this article, we will be covering everything above ETFs, like what are ETFs, how they work, what are the advantages and disadvantages of investing in an ETF as compared to the index funds, etc.

So, let’s dive right in.

What are ETFs?

ETFs are basically mutual funds that pool investors’ money and invest it in an underlying asset, that could be an index, a commodity, or bond, etc. The ETF then tries to replicate the performance of its underlying asset.

These ETFs are introduced through their NFO, and then are listed on the exchanges, So they have the characteristics of a Mutual fund as well as a stock. Because an ETF can be traded like stocks but is managed by a mutual fund.

These funds follow the principle of passive investing, i.e Investing in an asset, and holding it for the long term, with minimal buying and selling of the assets, these funds usually try to replicate the returns of its underlying asset. This is different from active investing, where mutual funds try to beat the benchmark index’s returns.

Some of you might have a question: why should one opt for an ETF, when we have index funds, which have many added benefits, and of course some drawbacks, we will talk about them later.

So, what used to happen is that a few years back the expense ratios of index funds used to be pretty high as compared to the ETFs, so most of the investors were in favor of investing in ETFs rather than the index funds, to save some costs.

But, now things have changed a bit, due to neck-to-neck competition between various funds, the costs, i.e expense ratios have come down pretty drastically in the last few years.

Though still, ETFs are a cheaper option, but not so much that you would just ignore index funds, as they have their own added benefits like you can do SIP with index funds whereas there is no option of SIP in case of an ETF, also you can invest any amount in an index fund (minimum 500), i,e 500, 600, 1200, etc., but if you are investing in an ETF, you have to invest in the multiples of whatever the price of the ETF is, i.e If the ETF is priced at 100 Rs, then you can only invest in multiples of 100 like you do when you buy stocks.

But, there are a few reasons why ETFs are gaining popularity nowadays

1. Transparency

The number one reason why investors like to invest in ETFs is that they are very transparent. How? Because when you are investing in a mutual fund, you don’t know in what companies the fund manager will invest your money, there’s a lot of discretion involved in it, so it depends on the fund manager, how your portfolio will do in the future, but when you are investing in an ETF you know that it’s going to replicate the performance of its underlying asset.

2. Low expense ratio

As ETFs are passively managed funds, i.e Unlike actively managed funds where fund managers actively try to buy and sell the stocks, the ETF are usually passively managed and does not require active buying or selling, so obviously it leads to a low expense ratio as compared to the Actively managed mutual funds.

3. Flexibility

ETFs can be bought and sold on the exchanges anytime during market hours, whereas mutual funds are only traded once per day after the market close, though it’s not a big deal for a long-term investor, as they buy and hold for a long term. But, having an option is much better than not having it.

4. Diversification

If you are buying an ETF off an index, you are basically investing in a basket of stocks, so obviously you will get fewer drawdowns as compared to investing in one stock, obviously at the cost of Higher returns.

5. Lower Tracking error

ETFs tend to have lower tracking errors as compared to index funds because the index funds have to maintain some cash at all points to fulfill the redemption requests, i.e when you sell your index fund. Remember: the lower the tracking error the better will be your returns.

Some terms that you should understand before investing in ETFs. ~

1. Expense ratio

The expense ratio is the annual fee that is charged by every mutual fund. It is a measure of the annual fund operating expenses of an investment fund, A fund’s management fee is also included in the expense ratio.

2. Tracking error

In simple terms, It is the difference between the performance of an ETF and its underlying asset. Say if Nifty 50 gives 20% return in the next 1 year, but its ETF only gives 19.5% return, the difference between the performance is tracking error, i.e 0.5%.

Types of ETFs

Different types of ETFs are available in the market, below are some examples.

Index ETF

These are the most common types of ETFs that are available in the market, It aims to track a particular market index like Sensex, Nifty, BSE 100, Nifty 100, etc.

Gold ETF

Gold ETF is an exchange-traded fund that aims to track the price of gold in the market, It’s an ideal way to get exposure in a variety of sectors like gold mining, manufacturing, etc.

International ETFs

An international ETF is an ETF that invests in foreign-based securities, An international ETF may track global markets, or track a country-specific benchmark index.

Liquid ETFs

Liquid ETFs invest in a basket of short-term Government securities, like Collateralized Borrowing and Lending Obligations (CBLO), Repo, and Reverse Repo securities.

The aim of a liquid ETF is usually to provide an income commensurate with low risk, but at the same time, provide a high level of liquidity.

So, that’s it for today from our side, we hope that you learned something new and if you did then do share it with your friends over social media.

Thanks for reading!