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Whether you are a new investor or an experienced professional, adding a few Exchange Traded Funds (ETFs) to your portfolio can help grow your investments. For a seasoned professional, ETFs offer low-cost intra-day trading. If you are a new investor, the fundamentals of ETFs are easy to understand, and with its knowledge, you could be acquainted with the securities markets.
Let’s know more about ETFs and its benefits
What is an ETF?
An Exchange Traded Fund (ETF) is similar to the index fund and is traded just like any other stock on a stock exchange. It experiences fluctuations due to the buying and selling that occurs throughout the day. It may track a basket of equities, a commodity, a bond or, an index just like an index fund.
An ETF is similar to a mutual fund regarding diversification and transparency. An ETF has a low cost as it follows a passive investment style with low turnover and its sale price is very close to the actual NAV of the scheme.
Why invest in ETFs?
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Inexpensive Investment
An expense ratio is similar to annual fees charged to cover a fund’s total annual operating expenses. You can view the expense ratio in a fund’s prospectus and shareholder reports. The expense ratio for ETFs is much lower than the fees charged by mutual funds. This is because ETF trade usually takes place with other investors and not with the fund company. However, you need to pay a commission to the broker while investing.
Presently, ETFs are available at an expense ratio as low as 0.5%. This is lower than the average expense ratio of an index fund, which is around 1.3%.
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Flexibility
A mutual fund can only be bought and sold at the end of the day’s Net Asset Value (NAV) whereas an ETF can be traded at real-time NAV. This is because ETFs are traded just like stocks and thus can be bought and sold throughout the day.
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More tax efficient
An investor pays taxes for capital gains and dividend income derived from both, ETFs and mutual funds. In ETFs, there are fewer taxable events as they are simply traded between investors. Fewer taxable events mean lower tax liability. Thus, an ETF is more tax efficient than a mutual fund.
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Intraday trading
Intra-day trading is possible at a meagre cost with an ETF. Intra-day trading can get very expensive in the case of closed-ended mutual funds, whereas with open-ended mutual funds, intraday trading is not possible.
Active vs Passive Mutual Funds
Mutual fund investments may be either actively or passively managed. Passive ETFs mutual funds are designed to mimic an index focusing on equities or commodities of a basket of an asset class. In actively managed funds, a team of fund managers select securities with the intention of outperforming the index.
In an efficient market, where it is difficult to outperform the index, fund managers often suggest investing in passive funds. However, active funds are popular for exceeding in the general market and thus show higher growth potential. A smart investor can benefit from a blend of both actively and passively managed funds.
ConclusionFor new investors, starting with a small corpus, ETF is an inexpensive choice. Based on the investor’s risk appetite, ETFs provide better risk-adjusted returns compared with sector or stock specific investments. Lower expense ratio and cost efficiency make ETFs the right funds to grow your portfolio.
