ETF FUNDS
An ETF, short for exchange traded fund, is just like a stock and can be also called a basket of securities that also trade on the stock market. Exchange traded funds pool the financial resources of several people and use it to purchase various tradable monetary assets such as shares, debt securities such as bonds and derivatives. Most ETFs are registered with the Securities and Exchange Board of India (SEBI). It is an appealing option for investors with limited expertise in the stock market.
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How Do Exchange Traded Funds Work?
If you are wondering what is an ETF fund or how it works, as mentioned earlier, ETFs share characteristic features of both shares and mutual funds. They are generally traded in the stock market in the form of shares produced via creation blocks. ETF funds are listed on all major stock exchanges and can be bought and sold as per requirement during the equity trading time.
Changes in the share price of an ETF depend on the costs of the underlying assets present in the pool of resources. If the price of one or more asset rises, the share price of the ETF rises proportionately, and vice-versa.
Types of ETFs
The most common types of ETF funds in India are:
Equity ETF
These represent companies investing in shares and other forms of equity of various organisations.
Gold ETF
This is a commodity exchange-traded fund primarily involving physical gold assets. Purchasing shares of this company allows you to become the owner of gold on paper, without the burden of asset protection.
Debt ETF
Enterprises trading in fixed return securities such as debentures and government bonds are often called Debt ETFs.
Currency ETF
Currency ETF funds mainly profit due to the fluctuation of the exchange rates. They purchase the currency of different countries based on calculated predictions about the future performance of that currency. Currency ETFs follow not only the stock exchange trends but also the political and economic scenario of the respective countries.
Types of ETFs
A Diversified Pool of Securities
Purchasing shares of a company keeps you limited to the performance of that company itself, subjecting you to a higher degree of risk. On the other hand, investing in exchange traded funds allow you to keep your finances spread over equities of different companies – diluting your risk significantly. Even if one asset underperforms in the pool of resources in an ETF, it can be compensated by the exceptional growth of other assets.
Benefits over Mutual Funds
One of the significant benefits of investing in an ETF over mutual funds is the reduced expenses. There are various charges involved in mutual funds, such as entry and exit load, management fees, etc. This increases your total cost incurred, and thereby the total expense ratio of mutual funds. As ETFs are traded like shares in the stock market, its expense ratio is considerably lower.
Tradable security
Any changes in the value of an ETF can be observed instantly and can be bought and sold throughout the business day. Thus, we can conclude that ETFs have much higher liquidity than mutual funds. This enables you to have flexibility in your choices of investing, allowing you to shift to another security with ease in case a particular asset is not generating adequate profits.
Tax-Friendly
ETF funds are more tax-friendly than mutual funds. Even though both are subjected to capital gains tax and dividend taxes, the relative amount of fee charged on ETFs is much lower than the one levied on mutual funds.
Passively managed
Investing in ETFs is generally less risky than mutual funds as they are passively managed. They only invest in the best-performing companies listed in a particular stock exchange, while mutual funds thoroughly assess all the businesses with a potential for growth. This subjects mutual funds to a greater risk as newly formed small scale companies have higher chances of incurring a loss.
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