Mutual funds and stocks are two of the most preferred options for investments are probably the most confusing ones too. If you are an investor, you must have surely faced a dilemma to choose one out of the two for your investment needs. While mutual funds offer the benefits of diversification, stock trading comes with own ease. But have you ever wondered what if there existed a product which could offer you the best of both the worlds?
Well, ETF or Exchange Traded Funds are the solution here. ETFs offer you the ease of stock trading with the diversification benefits of mutual funds. ETFs combine the nest attributes of both these asset class. ETF is a fund which can be traded on stock exchange similar to shares or stocks. ETFs consist of a basket of underlying assets similar to mutual funds, which are managed by the fund provider. These assets can include shares, bonds, commodities or even a combination of all these. ETFs are traded through brokers.
Let us discuss in detail about Exchange Traded Funds including the basics, pros and cons and type of exchange traded funds. We will also have a brief comparison of Exchange Traded Funds with Stocks and Mutual Funds to make your investment decision easier.
Exchange Traded Funds have been one of the most innovative and popular ways of investing in the market from the last few years. Let us now discuss in detail about ETFs.
What is ETF?
ETFs or Exchange Traded Funds are a type of fund which can be traded on stock exchanges like a share. ETFs contain a basket of underlying assets and you can buy and sell the complete basket without having to trade in the components individually.
ETFs are managed by fund providers or fund managers who own and manage the underlying assets and design a fund in accordance to monitor the performance. They further sell shares in the fund to traders and investors. Similar to owning a stock of company, the investor owns a part of the ETF, without directly owning the underlying assets.
Even though ETFs have been designed to track the performance of underlying assets, they usually trade at prices determined by the market which are different from those of the assets. The underlying assets can be commodities, currency, stocks or even index like the NIFTY 50.
Types of ETF
Depending on the type of underlying assets, Exchange traded funds can be classified into number of categories. The different types of Exchange Traded Funds are:
1. Index Fund ETFThese are mainly a passive Mutual Fund which allows the investor to buy a pool of securities in one transaction. These funds have the objective of tracking the performance of Stock Market Index like the Nifty 50. Whenever you buy or invest in an Index Fund ETF, you are actually buying a part of a portfolio which has the stocks of the underlying asset.
2. Gold ETF: These ETFs invest in gold bullion and thus are based on the prices of Gold. These funds track the performance of Gold bullion. The prices of these ETFs are directly dependent on the prices of Gold, which means that with the rise in prices of Gold, the value of the ETF will also rise and vice versa.
3. Leveraged ETF: These ETFs use derivative and debt instruments to boost up the returns extracted from an underlying index. These are considered to be appropriate only for short term investments. Leveraged ETFs are currently not available in India.
4. Bond ETF: These ETFs are similar in nature to the Bond Mutual Funds. Bond ETFs include portfolio of bonds and are usually managed passively. There are plenty of Bond ETFs available in India for trading and investing.
5. Sector ETF: As the name suggests, sector ETFs include stocks and securities form a specific industry or sector. Some of the commonly traded Sector ETFs include Pharma Funds, Technology Funds etc. These funds include stocks from their specific sector.
6. Currency ETF: This type of funds allows the investor to be a participant in the currency market without directly trading in any specific currency. This type of funds may include a pool of currencies or even a single currency. The main objective of Currency ETFs is to track the movements of currencies.
Benefits of investing in ETFs
Investing in Exchange Traded Funds comes with many benefits. Some of the main advantages of investing in ETFs include:
1. Liquidity:ETFs provide the convenience of buying and selling them anytime during the trading period. This makes them a liquid investment instrument.
2. Low Cost: ETFs provide the convenience of buying and selling them anytime during the trading period. This makes them a liquid investment instrument.
3. Tax Advantage: ETFs are very tax efficient because the buying and selling of the underlying assets in the open market does not affect the tax obligation of ETFs.
4. Exposure: ETFs provide a diversified exposure to a specific category or sector depending on the case and type of ETF.
5. Transparency: The investment holdings of ETF are published every day. Thus, there is a high level of transparency in ETF.
Conclusion
ETFs of Exchange Traded Funds can be a very good investment option as it provides you with the combined benefits of trading in stocks and mutual funds. ETFs have various advantages above Mutual Funds as discussed above but choosing the right ETF for you is not an easy task. If you are new to the world of ETFs and don’t have prior experience or knowledge about them , it is better to consult a SEBI registered investment advisor who can help you select the best fund for you depending on your needs and requirements.
Happy Trading!
