How ETFs Can Simplify Your Investment Decisions
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What are ETFs?
ETFs or exchange traded funds are mutual funds that are listed and traded on stocks exchanges just like shares. ETFs offer you a low-cost way to diversify your portfolio. With a single ETF share, you can take exposure to the entire stock market. If you don’t know how to analyse and pick stocks and mutual funds for your portfolio, ETFs are the right investment product for you. ETFs aim to replicate the performance of their benchmark index. ETF achieve this by purchasing securities in the same weightage as the benchmark index.
ETFs are available on wide a variety of indices and can give you exposure to many asset classes. You can invest in gold and Government Bonds through ETFs. If you want to park your funds in a safe short-term investment, there are ETFs available. If you want to diversify further by investing abroad, you can easily do that through ETFs. When it comes to equity ETFs, ETFs are not just about diversified benchmark indices such as Nifty 50. You can take industry specific exposure too through ETFs. For example, if you are bullish on banking industry but cannot decide a banking stock to invest in, you can invest in Bank Nifty ETF.
It is easy to construct a diversified portfolio with ETFs. If you want to create a portfolio that has 50% equity and 50% debt, you can simply put 50% of your money in an equity ETF and 50% in a bond ETF. Simple, isn’t it? ETFs present a simple and effective way to build a diversified portfolio for the long term.
How do ETFs differ from mutual funds?
Both ETFs and mutual funds are pooled investment vehicles. Yet, there are many differences between ETFs and mutual funds.
ETFs are passively managed i.e. there is no fund manager who selects the securities to buy and sell. The aim is to merely track the performance of the index and not beat it. For example, a Nifty 50 ETF will track the performance of benchmark index Nifty 50. When Nifty 50 goes up, the ETF price will go up. When the Nifty 50 goes down, the ETF price will also go down by the same amount. On the other hand, most mutual funds, except index funds, are actively managed. The aim of the actively managed funds is to beat their benchmark index, an aim that these funds may not always be able to achieve.
ETFs have lower expense ratios than mutual funds. Actively managed funds have expense ratios ranging from 0.5% to 2.5%. Even passively managed index mutual funds have expense ratios ranging from 0.25% to 1% per annum. The expense ratio of ETFs is much lower and ranges from 0.05% to 0.25% per annum. Lower cost means better returns. A 0.5% reduction in cost will result in a portfolio that is higher by ~5% over 10 years, ~10% higher over 20 years and ~15% higher over 20 years.
You can buy and sell ETFs on the stock exchange throughout the day just like shares. Therefore, ETFs present an opportunity to benefit from the intraday market movements too. On the other hand, mutual fund units do not trade on the stock exchanges. You can transact in mutual funds only at the day end NAV, declared by the fund house. Moreover, there is no exit penalty in case of ETFs. You don’t have to worry about any exit penalty. With mutual funds, you must pay a penalty if you exit before a specified period. Thus, ETF provide greater flexibility compared to mutual funds.
How to buy ETFs?
You must have a Demat account to hold ETFs units. There are two ways to purchase ETFs. You can buy the ETFs at the time of New Fund offer directly from the fund house. The other way is to purchase ETFs on stock exchanges just like you purchase shares. You can buy the ETFs through your brokerage account and the units will get credited to your Demat account.
Where do you start?
You can check the list of actively traded ETFs on the NSE website. If you are a new investor, you can start with an ETF that tracks a diversified benchmark such as Nifty 50 or Nifty 100. Experienced investors can select an ETF from a wide range of ETFs available in the market according to their needs.
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