What is an ETF in the Stock Market: All investors need to know
As the name suggests, ETFs or Exchange Traded Funds are traded directly on the exchange throughout the day and it includes index-based products that do not require active management, you can buy and sell ETFs any time you want during the market hour. Exchange traded funds pool money from investors just like mutual funds and use it to purchase assets such as stocks, bonds, and derivatives. A beginner in the stock market having limited expertise about it can opt for investing in ETFs.
What is ETF fund?
In simple words, ETF funds can be described as a marketable security that tracks an index, a basket of assets like an index fund, bonds, or commodities, and these ETF funds are traded on stock exchanges like common stock.
How do ETFs work?
ETFs stand for Exchange traded funds and can be traded directly on the stock exchange and it offers investors to invest in a fund that replicates the performance of a basket of stocks ( generally an index). One can invest in ETFs by buying units directly from the stock exchange during the trading time and like equity stocks, they have tickers (e.g., SPY). ETFs are listed on important stock exchanges and the price is determined by demand and supply just like stocks. Hence, the price keeps on changing during the market hour based on the change in the price of underlying assets.
Investors are provided adequate liquidity and also fair prices while investing in ETFs. Since ETFs are traded directly on stock exchanges, you need a Demat account to buy ETFs.
Therefore, ETFs can be bought and sold during market hours of the stock exchange just like equity stocks but ETFs do not offer intraday buying or selling to investors. Investors can opt for buying ETFs for better diversification of their holdings.
How to invest in ETFs?
Firstly, investors start by figuring out what they desire from their portfolios as there are thousands of ETFs available with different focuses: some ETFs track stock indexes, some emerging technologies or market segments, and some are based on particular investment strategies.
Once an investor analyzes what they want from their portfolio, they can do their thorough research and pick out one or more ETFs that are meeting their requirements.
Types of ETFs
- Equity ETFs: Equity ETFs are the most famous at present and they generally track Nifty 50 and other alternatives. Some of the examples are ICICI Pru NIFTY 100 ETF, Nippon India ETF Nifty midcap 150, DSP Nifty 50 ETF, and Aditya BSL Nifty Next 50 ETF.
- Bond ETFs: Bond ETFs include fixed income instruments like government bonds and debentures. Bond ETFs include debt instruments, with stocks and mutual funds. Examples are government securities (G-Secs) and the Nifty Bharat Bond.
- Gold ETFs: Gold ETFs offer opportunities for investors to invest in precious metals digitally, instead of investing in physical gold. Gold ETFs track gold prices in the market. You can simply become the owner of gold without worrying about its protection. For example, Nippon India ETF Gold BeES
- Currency ETFs: Investors can earn profit by investing in Currency ETFs as the exchange rates keep on fluctuating. Investors get exposure to investing in overseas currencies. The Forex market is a marketplace where trading in currencies takes place. For example, Invesco DB US Dollar Index Bullish Fund
- International ETFs: International ETFs offer investors the opportunity to invest straight in foreign companies. They try to replicate the index of global markets. For example, Mirae asset NYSE FANG+ETF, HDFC world index fund, MOSL NASDAQ 100.
Benefits of investing in ETFs
- Diversification: Investing in ETFs allows you to diversify your portfolio efficiently, without worrying about selecting individual stocks or bonds. Most ETFs cover major asset classes and sectors, providing you with a broad selection. ETFs like regional ETFs, international ETFs, or specific industry ETFs allow you to access sectors that you may find difficult to invest in. diversification in different asset classes minimizes the risk of your portfolio because when one asset underperforms in an ETF, other assets will compensate by growing exponentially.
- Low Cost: Most ETFs are less expensive than mutual funds and that makes them a low-cost investment option. Mutual funds charge entry and exit load, expense ratio, management fees, etc whereas ETFs charge comparatively lower expense ratios than mutual funds.
- Tax-efficient: ETFs are tax-friendly due to lower turnover and redemption process. ETFs charge comparatively lower fees than mutual funds because the capital gains and income from the ETFs are lower.
- Passive management: The objective of ETFs is to replicate the market and the fund manager only needs to make occasional changes to match a market index and as they are passively managed, they are less riskier than mutual funds.
- Liquidity: ETFs are traded on stock exchanges like any other stock and any change in the value of an ETF can be noticed instantly and can be traded throughout the market hour of the day. Therefore, ETFs have more liquidity than mutual funds and more liquidity enables you to have a variety of choices to invest with ease.
Things to keep in mind while investing in ETFs
- ETFs with low volumes lack liquidity as you may not find sufficient buyers to sell your stock.
- ETFs are riskier than fixed income assets like treasury bills, bonds, and certificates of deposits (CDs), although some ETFs comprise a mix of stocks and bonds and some others comprise either bonds or stocks exclusively. The higher the proportion of bonds in an ETF, the lower the risk.
- ETFs can also comprise commodities (like oil) and currencies (like the Dollar), which are riskier than bonds. Overall, the riskiness of an ETF depends on the asset class it comprises.
Difference between ETFs and Mutual funds
|Exchange-traded funds can be bought and sold during the market hour of a trading day|
Mutual funds can be bought or sold at the closing net asset value.
|ETFs have fewer operating expenses|
Mutual fund operating expenses vary from fund to fund.
|ETFs do not provide any minimum investment option|
Mutual funds have minimum investment options available for investors having a low budget.
|ETFs track an index by assembling a portfolio that should match the index constituents|
Mutual funds are actively managed by fund managers and assets are chosen in such a way that they should beat the benchmark index.
|ETFs do not have limitations on time to sell an asset as they can buy or sell anytime during the market hour|
Mutual funds may charge a penalty if you sell the share early.
Are ETFs good for beginners to invest in?
ETFs are a great way to start investing in the stock market as they are comparatively inexpensive, available through traditional brokerages, and are less risky than investing in an individual stock.
How do ETFs vary from mutual funds?
One key difference between ETFs and mutual funds is that most ETFs are index funds while mutual funds require an active strategy that enables them to outperform the market index.
Why are ETFs admired by investors?
ETFs have been around for almost 25 years, they have become popular in the past five years because of low cost investing.
Are ETFs less expensive than mutual funds?
No, ETFs are not necessarily cheaper than index mutual funds.
What are ETFs in India?
In India, mostly ETFs are registered with the Securities and exchange board of India (SEBI) and it includes a basket of stocks (Indices) that can be traded on the stock exchanges.