Have you heard the term ETF? Even I have heard this term off lately and got to know that ETF is Exchange Traded Funds. But what are Exchange Traded funds? Let’s check it out that below quickly.
What are Exchange Traded Funds?
Exchange-Traded Funds or ETF are funds that pool the resource from investors and invest in assets such as shares, commodities, gold, etc. In short ETF’s are similar to mutual funds who also collect money from investors and invest in financial assets.
However, ETF’s are different from Mutual funds in the way they are listed and traded in the Stock Exchange just like shares. One should note that ETFs are registered with the Securities and Exchange Board of India (SEBI).
But Why ETF’s?
As ETF’s are listed securities, it is as good as buying shares of many companies with the amount of investment at disposal. It would not be possible for an investor to purchase shares of many companies. Similar logic goes for commodities hence ETF acts as a mediator who pools the money from investors and invests in the market.
Secondly, investors don’t have the expertise to analyze and screen the shares. ETFs are managed by professionals whose job is to invest and grow investors’ money.
Does ETF’s are risky?
As ETF’s are traded in the stock exchange, the unit price of ETF’s changes basis its underlying stock/commodity(i.e. changes in share prices/commodity prices) in the market. So yes, there is a risk associated with ETF too as they are market-linked derivatives.
Benefits of ETFs
- Diversification- ETFs invest in multiple securities and sometimes even invest in an index like SPDR S&P 500 ETF which tracks the S&P 500 Index. Diversification reduces the risk as compared to investment in single security. A loss in one scrip can be compensated by the gain in other scrips.
- Real-time trading- ETFs are real-time traded in exchange hence you need not wait for the day to end to check the NAV like mutual funds. ETF’s are more liquid than Mutual funds.
- Paperless form- ETF can be bought through Demat account so you need to maintain copies of ETF.
- Lower expense ratio- As passive ETFs usually copy the investment pattern of the index they don’t need to be regularly monitored by the fund manager. Hence the management cost of passive ETF is less. Also, there is no entry and exit load in ETFs.
Limitations of ETFs
- Demat Account- As the ETF is traded in exchanges, an investor has to open the DEMAT account to procure ETF. This would be difficult sometimes for a novice.
- Growth opportunities- As passive ETFs follow the index, any growth or loss in index leads to the corresponding impact of ETF. Also, passive ETF follows securities of blue-chip companies thus overlook the small companies with high growth.
Types of ETFs
There are many ETFs trading in Stock exchange but I will classify ETFs in the following broad categories.
- Equity – These ETFs are those which invest in securities or passively invest in Indexes. They also invest in other forms of equity in organizations.
- Debt – This type invests in debt instruments such as government bonds, money markets, etc.
- Gold ETF- This is the latest type of ETF which is traded in exchange as a commodity ETF involving physical gold. Investing in this ETF permits you to purchase gold in paper form.
- Currency ETF- This one invests in the currency of different currencies based on future performance expectations. An investor gains with the exchange rate fluctuations with this ETF investment.
Top 5 ETF in 2020
So that’s it from this article. I am sure after this article you won’t be bothered by the question “What are Exchange Traded Funds?
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