ETF - Exchange Traded Funds

Understanding How ETFs Work

ETFs are usually traded on the stock exchange as shares made through a list of names and quantities of securities and assets. These funds are traded on all major stock exchanges and may be purchased and sold as needed during regular equity trading hours.

The costs of the underlying assets in the pool of resources influence the price fluctuation of ETFs. When the value of one or more assets rises, so does the value of the ETF's shares and vice versa. The value of an ETF's dividend is determined by the company's performance and asset management.

As per company policies, they may be managed actively or passively. A portfolio manager operates an actively managed ETF after carefully evaluating stock market conditions and taking a calculated risk by investing in high-potential companies. On the other hand, passively managed ETFs invest in businesses with increasing charts, following the trends of specific market indices.

Types of ETFs

Regardless of your investment goals, almost all investors may profit from ETFs, be it for income generation, price appreciation, or partly offsetting risk in your portfolio. 

You may choose to invest from the following ETF types:

1. Bond ETFs

   Bond ETFs provide investors with a steady stream of income. The performance of the underlying bonds affects their income distribution. Bond ETFs do not have a maturity date, unlike their underlying securities. They usually trade at a higher or lower price than the actual bond price. Bonds are an excellent method to diversify a portfolio and reduce the risks associated with investing.

2. Inverse ETFs

   When the value of an underlying benchmark declines, an inverse exchange-traded fund is created by utilizing different derivatives to benefit from the decrease in the value of that benchmark. It is comparable to maintaining a variety of short positions, which involve borrowing securities and selling them in the hopes of repurchasing them at a lesser price.

3. Currency ETFs

   Currency ETFs allow investors to participate in currency market activities without having to buy a specific currency. Currency ETFs, which are pooled investment vehicles, monitor the performance of both local and foreign currencies. Currency ETFs may be used for several purposes. They may be used to speculate on currency exchange rates based on a country's political and economic developments.

4. Index ETFs

   The most popular ETF product is index ETFs. Its goal is to follow a specific market index, such as the Sensex, Nifty, BSE 100, or Nifty 100. Index ETFs invest in a portfolio of companies that closely resemble the index that the ETF is attempting to follow. When you buy an Index ETF, you should expect to receive the index returns that the ETF tracks, nothing more or less.

5. Gold ETFs 

   Gold ETFs are physical gold-based commodities exchange-traded funds. By buying shares in this business, you may possess gold on paper without worrying about asset protection.

6. Liquid ETFs 

   These funds invest in a basket of short-term government securities like money market instruments with short maturities to reduce price risk and increase returns while maintaining liquidity.

Pros and Cons of ETFs

There are several benefits to investing in an ETF rather than mutual funds or corporate stock.

1. Pros

   • Investing in ETFs allows you to diversify your portfolio and reduce your risk. The extraordinary growth of other assets may compensate for the underperformance of one asset in an ETF's resource pool.
   • ETFs have lower costs than mutual funds, which is one of the significant advantages of ETFs over mutual funds. Entry and exit loads, management fees, and other costs are all part of mutual fund transactions. Since ETFs move like stocks, their cost ratio is lower.
   • ETFs are considerably more liquid than mutual funds. If a specific asset isn't doing well, you can easily switch to another.
   • Even though both are subject to capital gains and dividend taxes, ETFs charge a considerably smaller percentage making them tax-friendly than mutual funds do.
   • The fact that ETFs are passively managed makes them less risky than mutual funds. In contrast, mutual funds carefully evaluate all firms with growth prospects. Newly established small businesses are more likely to lose money, putting mutual funds at greater risk.

2. Cons

   • The fact that ETFs move like stocks means that they come with several associated costs. Fund managers often do this for a small commission.
   • You may also trade on the stock market without the help of a fund manager. In such a case, a Demat account must be established. It is difficult for a beginner to operate a Demat account without a fundamental understanding of stock market operations.
   • ETFs traded on a stock exchange are susceptible to market movements. Unlike government bonds, they fluctuate. The stock market strongly influences profit or loss.
   • ETFs are somewhat diverse. They invest in the best-performing businesses on a specific stock market since ETFs are passively managed. ETF firms frequently overlook small companies with tremendous potential.

Why Should You Invest in ETFs? 

To minimize the bad experiences of the volatility of shares, a reasonable approach would be investing in ETFs as a stepping stone into stock markets. 

The significant reasons why should you invest in ETFs are:

1. ETFs Help You Diversify Your Portfolio

   An ETF investment owns many underlying assets instead of just one like a stock does. If you want to diversify your portfolio, ETFs are a popular option; they contain various assets – one ETF may hold hundreds or thousands of assets from multiple sectors or be limited to a single industry or sector.

2. ETFs Provide Flexibility

   Unlike mutual funds, ETFs may be bought and sold on stock markets. These funds may be exchanged daily like intraday trading. ETFs may be shorted and sold for a profit done in a single day within market hours.

3. ETFs Offer Liquidity

   ETF owners benefit from liquidity as well as broad diversity in their mutual fund portfolio. There is no lock-in since they are open-ended funds providing you with the option of withdrawing your assets as needed.

4. ETFs Do Not Have a Lock-In-Period

   ETFs have no maturity time since they may be exchanged daily. This provides liquidity and gives you the freedom to sell your assets whenever you choose. Due to the lack of a holding period, ETFs are a good investment choice.

5. ETFs Are One-Time Transaction

   When you buy a mutual fund, you're purchasing a basket of equities made up of tiny shares spread over a variety of assets. However, you may buy an ETF in a single transaction, the same as owning a small portfolio. This helps you in monitoring performance. 

6. ETFs Are Tax-Efficient

   Being treated as equity-oriented schemes, ETFs are taxed like most other equity-related investment plans.

Difference Between Mutual Funds and Exchange-Traded Funds

One of your most difficult decisions as an investor is choosing between a mutual fund and an exchange-traded fund (ETF). Even though both these items are identical, their core is different. 

The following are the significant distinctions between mutual funds and exchange-traded funds.

• Mutual funds are transacted at their NAV (net asset value) at the end of the day, while ETFs are bought and sold throughout the day, and their value fluctuates.
• Mutual funds may only be bought from the funds directly at the NAV price, set throughout the trading day. ETFs can be traded at the current market price on the stock exchange at any time.
• Transaction fees of mutual funds are often not applicable compared to ETFs, whereas you have to incur transaction fees on ETFs.
• The operation costs of MFs are diversified. However, the operational costs of an ETF are lesser compared to mutual funds.
• You may be charged a penalty on some mutual funds if you sell your stock before 90 days from the date of purchase, whereas ETFs are not subject to a time restriction. You may purchase or sell an asset in an ETF at any moment throughout the trading day at the current price. 
• Mutual funds have less liquidity because it is not linked to their daily trading volume. ETFs have greater liquidity. The index’s stocks determine the liquidity of an ETF.
• The majority of mutual funds have a minimum cost ratio. Exchange-Traded Funds have no minimum investment requirements.
• ETFs have fewer tax obligations than mutual funds. Because of the way ETFs are created and redeemed, they provide you tax advantages as an investor.

How to Trade/Buy ETFs?

ETFs are comparable to mutual funds in many ways, but they trade like stocks. ETFs may help you get the benefits of diversification with a basket of assets while also enabling you to benefit from price fluctuations since they trade like stocks throughout the day. 

Purchasing ETFs is simple. ETFs are mutual funds that trade like stocks on a stock market. They're a straightforward, low-cost, and tax-efficient method to invest.

You can trade ETFs in 5 easy steps as under:

• Choose after comparing the most appropriate online stock trading platform for you.
• Register for a Demat account and a trading account.
• Furnish personal information as well as documentation of identification. 
• Transfer/ deposit funds into your trading account
• Find the ETF you're looking for and place a purchase order. Keep track of your ETF performance regularly. 

High-Performance ETFs 

Some of the high-performance ETFs are listed below:

1. Gold ETFs

   • Aditya Birla Sun Life gold ETF 
   • SBI - ETF Gold Invesco India Gold ETF
   • Axis Gold ETF 
   • Kotak Gold ETF 
   • HDFC Gold Exchange Traded Fund 
   • UTI Gold Exchange Traded Fund

2. Index ETFs

   • HDFC Sensex ETF
   • SBI ETF Sensex
   • UTI Sensex ETF
   • Motilal Oswal NASDAQ 100 ETF 

3. Sector ETFs

   • Kotak NV 20 ETF
   • Nippon ETF Consumption
   • ICICI Prudential NV 20 ETF

4. Currency ETFs

   • Market Vectors INR/USD ETN
   • Wisdom Tree INR Strategy Fund

5. Bond ETFs

   • Nippon ETF Long Term Gilt
   • SBI ETF 10 Year Gilt

Final Thoughts 

There are many benefits to investing in an ETF over mutual funds or stock. Still, you should be aware of the complete facts about the ETF available on financial company websites through the ETF prospectus. Invest in what you know. 

Complicated financial products should be presented in terms of how they will help you achieve your goals. Finally, seek the counsel of a financial expert.

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