ETFs are abbreviated as Exchange Traded Funds and are one of the investment products you can place your funds into for returns.
Let’s try to understand how an ETF works and whether it suits your trading and/or investment requirements.
ETF – Introduction
In very simple words, it can be said that ETF (Exchange Traded Funds) is a tradable instrument that mainly helps in tracking bonds, commodity etc. This fund is highly beneficial in terms of investment to the small and big investors.
Similar to index mutual funds, exchange-traded funds can help in diversifying one’s portfolio. The best thing about this fund is that it can be sold or bought in two different ways.
Some of the main attributes associated with this fund are tax efficiency and low management costs. Getting started with exchange-traded fund requires a trading account with a broker and a Demat account for keeping the units of ETF.
Click here to get a callback for a trading account.
There are multiple types of ETFs you may choose to invest in, including:
Fixed Income Funds
Real Estate Funds
ETF – How it Works?
ETF provides its investors with a beneficial method to pool their money in bonds, stocks etc. in order to receive an interest in the investment pool. With this fund, you won’t be able to directly sell its individual shares to the investors.
Thus, it can be said that all those participants who’re authorized can purchase or redeem shares directly from this fund.
There are two conditions of this fund when its share is trading at discount and at a premium.
When trading at discount, the price of the fund is lower than the value of the holdings.
When trading at a premium then the price is higher than the value of the holding.
Some of the top features of an ETF are listed below:
Transparency: In this fund, investors can see what they’re buying. Investors will get know what the fund is consisted of.
Tax efficiency: Exchange traded fund provides excellent tax profit than mutual funds. This kind of fund only sells securities so that changes can be replicated in its underlying index.
Professional management: It can be managed by investment advisers.
Low fees: One of the best features of this fund is that there is no need to pay more on the annual fee. In fact. it has a low annual fee in comparison with mutual funds.
Diversification: This fund is attributed with diversification which means an investor will get a diversified portfolio. There are chances that this portfolio may have lower variability in comparison with individual securities.
Flexibility in trading: It is known to everyone that this fund trades on an exchange which allows the investor to sell them anytime just like regular stocks. But, with mutual funds, investors don’t get this chance. Thus, it provides high flexibility trading.
ETF – Example
No doubt, ETF is considered a pooled investment vehicle which means it provides a way to the investors to pool their money in funds. To make it clear, let’s understand this with an example.
Let’s say there are some investors who’re looking and searching for the best way to invest in the stock market.
One option that each investor can go with is buying some stocks. But, managing the portfolio of stocks requires a lot of resources and time. So, it would be difficult to go with many shares in one go. If all the investors will decide to go together as one then they can pool their money.
They can also hire a professional manager so that he/she can invest for them. For keeping the record of everyone’s investment, each of the investors will get shares that would represent the stake of the total investment. This is all about exchange-traded funds.
In simple words, the asset of every investor is pooled in this fund and all the assets are invested as per the investment objective. Each share of the fund is considered with an undivided interest in the underlying assets of the funds.
ETF – Benefits of Investing
There are many positive aspects of the exchange-traded funds which an investor needs to understand. Some of the pros of these funds are:
Liquidity: It means that an investor is free to sell the holdings and to retrieve money from the sale.
Dividends can be reinvested: One of the main advantages of this fund is that the dividends of any company can be reinvested without any hassle in an open-ended exchange-traded fund.
This fund can be purchased on margin and sold for any short time.
One of the best parts of using this fund is that it allows the investors to manage risk. Investors can manage the risks by trading just like a stock.
As the tax on capital gains is paid on sale, this fund is considered for tax efficiency.
ETF – Concerns
There are always 2 sides of the coin. Some of the negative aspects of this fund are mentioned below which needs to be clearly considered by the investor:
Higher costs: When the investor will compare exchange-traded funds to investing in any specific stock then he/she will notice higher costs.
There are also chances that the buy and sell price of the shares can vary from the total asset value of the underlying index. This will result in reducing the return of the shares.
This fund is best for short-term exchange traded fund traders but for long-term traders, it is a complete disadvantage. Thus, these funds do not suit you if you are a long-term investor.
There are international limitations with some funds.
One of the main disadvantages of this fund is that it is volatile in nature. If there’ll any effect on the stock markets trading patterns this will also affect the exchange-traded funds.
ETF – Conclusion
It can be concluded that ETF (Exchange traded funds) is mainly an investment fund that comes with some unique features. This fund can be bought or sold any time and can be freely traded on a stock exchange.
It is considered a good investment option but not for everyone. This fund offers transparency to investors. There are many pros and cons of this funds that need to be carefully considered by the investors before investing in them.
Considering the pros and cons of this fund will let you know about the right type of fund for you.
If you are looking to invest in an ETF, why wait? Let us quickly help you with the investment formalities to get you started:
If you want to know more about the different aspects of the Indian stock market space, here are some reference articles for you: