Exchange Traded Funds (ETF)
ETFs stand for Exchange Traded Funds and are one of the most popular investment options for investors globally but many people have a question that what is ETF and exchange traded fund how to invest in ETF? So let’s discuss this topic.
What are Exchange Traded Funds?
An ETF is a type of investment fund that trades on stock exchanges just like individual stocks. But instead of representing a single company, an Exchange T traded Fund usually holds a collection of stocks, bonds or other assets.
An ETF is designed to track the performance of a specific index, sector, commodity or other asset class. For example, a Nifty 50 ETF would aim to mirror the performance of India’s Nifty 50 index, which represents the 50 largest Indian companies.
Let’s understand it this way-
Think of an ETF as a basket full of different fruits. Each fruit represents a different stock or asset. Buying one share of an ETF is like buying a piece of that fruit basket. You get a little bit of everything inside instead of buying each fruit separately.
How does it work ETFs?
We understood what an exchange traded fund means. Now we will understand how an ETF works. Then we will understand how to invest in an ETF. Just like companies launch their IPO (Initial Public Offering) before getting listed in the market, just like a mutual fund’s New Fund Offer (NFO), ETFs are also available for purchase from the fund house during the NFO period. However, after the NFO, the ETF units are listed on the stock exchange. Further purchase and sale of units happens on the exchange, just like stocks during market hours.
Exchange-traded funds also have symbols, like every company has a unique symbol to identify its shares. For example, IT company Infosys is listed on the exchange with the symbol INFY. Finance company Jio Financial Services is listed on the exchange with the symbol JIOFIN, and you can check the share price of Infosys by searching ‘INFY’. Similarly, every ETF has a unique ticker symbol as an identifier. For example, the ticker symbol of Nippon India ETF Gold BeES is GOLDBEES. By looking for this symbol, you can identify the ETF and find the current price.
Types of ETF-
Index ETFs:
Index ETFs are passive investment vehicles aimed at mirroring the performance of specific benchmark indices like the Nifty 50. Examples of index ETFs available for trading in India include UTI S&P BSE Sensex ETF, ICICI Pru S&P BSE 500 ETF, and HDFC Nifty 50 ETF.
Investors stand to gain capital appreciation when the associated index performs positively. For those who prefer to invest in the broader market rather than focusing on individual stocks, index funds offer a fitting choice. Additionally, they are economical options due to their minimal expense ratios.
Industry/Sector ETFs:
Industry/Sector ETFs are designed to target specific industries like banking, healthcare, technology, and more. These funds allow investors to invest in companies within a certain sector. Examples include Nippon ETF Infra BeES, Kotak PSU Bank ETF and SBI – ETF Nifty Bank.
Rather than putting your money into a single company, opting for an ETF that focuses on a specific industry or sector can often be a wise decision. Industry or sector ETFs allow you to gain exposure to numerous companies, thereby lowering the overall risk within your portfolio. This approach also supports diversification. If the sector as a whole does well, you stand to gain from capital appreciation.
To identify which sectors might be poised for success in the market, you can utilize the sector rotation analysis feature.
Debt ETFs:
Simple investment products that give investors exposure to fixed income securities are debt exchange-traded funds, or ETFs. The simplicity of mutual funds, the flexibility of stock investing, and the advantages of debt investments are all combined in these debt exchange-traded funds (ETFs). Like any other company stock, these debt exchange-traded funds (ETFs) are available for constant buying and selling at real-time market prices on the National Stock Exchange’s cash market.
Debt ETFs are index-based passive investment vehicles that allocate the same percentage of their investments to securities as the underlying index. An exchange-traded fund’s holdings are completely transparent due to its index mirroring property. Furthermore, ETFs have significantly lower expense ratios than mutual funds because of their distinct structure and creation process.
Gold ETFs:
Gold ETFs, one of the most well-liked ETFs, give investors exposure to the price of the safe-haven asset, gold. Without having to deal with the inconvenience of owning and storing physical gold, investors can take part in the fluctuations in gold prices on international markets by purchasing gold exchange-traded funds (ETFs). Despite being backed by actual gold, exchange-traded funds are simpler to purchase and trade than actual gold. They are great instruments for protecting against currency fluctuations and inflation.
International ETFs:
An exchange-traded fund with a focus on foreign securities is known as an international ETF. It might follow international markets or a benchmark index unique to a given nation. ETFs that invest in stocks or bonds from less developed nations are referred to as frontier markets or emerging markets ETFs. International ETFs only make investments in markets outside of the US. You can further diversify your global exposure with these funds, which hold a wide variety of foreign stocks.
Smart Beta ETFs:
By building a portfolio using a rules-based methodology, a smart beta exchange-traded fund (ETF) seeks to outperform conventional market-cap-weighted index funds. Smart beta ETFs, in contrast to conventional index funds, weight the securities in the fund using factors other than market capitalization.
Rather, smart beta ETFs employ alternative weighting schemes that take into account quality, volatility, value, momentum, and size in order to build a portfolio of securities that are intended to meet particular investment goals.
As an illustration, a value-based smart beta ETF might look to invest in stocks that are cheap according to ratios like price-to-book or price-to-earnings. Stocks that have demonstrated a robust upward trend in recent months or years may be included in an ETF with a momentum-based smart beta.
Exchange Traded Fund :How to invest in ETF?
Exchange Traded Fund: How to invest in ETF? This question remains in the mind of many people, so let’s understand through some steps how to start investing in ETF –
How to invest in ETF: Step 1-Create a demat or brokerage account.
How to invest in ETF step 1 ETFs can be bought or sold at any time on the stock market, just like regular stocks. In the same way that stock trading requires a demat account, investing in ETFs also requires one. Thus, opening a brokerage account is the first step. There are numerous brokerage firms in the market; some of the more well-known ones are Groww, Angel One, and Zerodha.
Before opening your brokerage or demat account, you can investigate various service providers and evaluate them based on fees, charges, commissions, etc.
Step 2 : Select an ETF
Selecting an ETF will be your next step after creating a demat account. ETFs are available in a variety of industries. The different kinds of ETFs have already been covered.
An essential step in the investing process is selecting the appropriate ETF. Stocks, bonds, commodities, and other assets are all included in ETFs. You should think about your time horizon, risk tolerance, and investing objectives before selecting an ETF.
You should investigate an ETF before selecting one by looking at its holdings, tracking error, expense ratio, market value, NAV, and past performance.
Step 3: Make Payment
You will need to pay for your investment after choosing an ETF. ETF funds will trade similarly to stocks. The money will be credited to your brokerage account and your transaction will be processed within two to three days of your payment. After that, you can monitor the ETF funds you’ve bought in your portfolio.
Hope you guys have understood how to investing in ETF. Let’s move ahead and understand what are its advantages and disadvantages.
Advandage and Disadvantages of ETFs
Advantage of ETFs-
1. ETFs make diversification easy:
Exchange-traded funds (ETFs) If you are looking to invest in
two or more stocks related to a single sector, you can choose ETFs related to
that sector, or you can invest in a variety of stocks at once. For example,
there are ETFs for gold and ETFs for the Nifty 50 companies. This greatly
reduces the amount of work needed to diversify your investment portfolio, and
even if you don’t have a lot of money to invest, you can still benefit from
this diversification. ETFs can be purchased for as little as a few francs.
2.ETFs are usually less expensive than mutual funds:
ETFs are priced just like a company, but not fixed prices
like mutual funds. The vast majority of exchange-traded funds (ETFs) are
passively managed. Managers of passively managed funds don’t have to actively
decide what to invest in; they simply replicate the composition of the fund’s
portfolio from an existing market index. As a result of this labor-saving
strategy, passively managed funds often have much lower fees than actively
managed funds.
It’s also unusual for active fund managers to consistently
deliver high returns over the long term. Index funds and passively managed ETFs
are usually a better choice. However, keep in mind that actively managed ETFs
are also available.
3. Investing in ETFs is simple:
ETFs have a lot of liquidity and are easy to use.
Stockbrokers make it easy to buy and sell ETF shares during trading hours.
Because of this, investing in ETFs is comparatively easy. It is a good idea to
compare stockbrokers. The brokerage and custody fees charged by different
stockbrokers vary greatly. Investing in asset classes other than stocks is also
made simple by ETFs. ETFs that invest in precious metals such as gold, silver,
platinum and palladium are one example. ETFs that invest in bonds and money
market instruments are also available.
4. ETFs are transparent:
One of the main benefits of ETFs is their transparency. You
can constantly monitor the daily performance of the ETF, as well as the
performance of each of its component parts. Additionally, the fund’s fees are
clearly displayed, usually as a total expense ratio.
Disadvantage of ETFs-
1.ETFs encourage risky investment practices:
ETF shares are easy to buy and sell. However, there is a
drawback. Concerned investors may be tempted to resell their ETF shares soon
after investing due to the straightforward and frequent trading ability of
ETFs, when the value of the portfolio is declining. This presents a problem
because the potential returns of a diversified ETF portfolio are usually only
realized over an extended period of time. ETFs are intended to serve as a basis
for long-term investing rather than day trading. This is a negative point.
2. You pay recurring charges:
Using an ETF to invest results in recurring expenses in the
form of fees levied by the fund’s managers, in contrast to investing in
individual stocks. The fund’s TER represents its annual fee. The returns you
receive on your investment are decreased because the TER is subtracted from the
fund’s assets. The TERs of the least expensive passively managed ETFs are less
than 0.1 percent annually.
The ETF’s index, theme, asset class, and investment strategy all have a
significant impact on fees. Comparing fund fees is a good idea when selecting
an exchange-traded fund (ETF) to invest in. Although it frequently takes more
work, investing directly in the asset rather than through an ETF can also be
less expensive depending on the asset class.
3.You are not eligible to vote for the underlying
companies:
After you buy shares and register as a shareholder, you
usually have the right to vote on important business decisions at the company’s
annual general meeting.
But this is not the case when you use an ETF to invest
indirectly in shares. Buying shares of an exchange-traded fund (ETF) does not
give you ownership of the shares the ETF invests in. The operator of the fund,
who is the legitimate owner of the shares, has the right to vote instead of
you.
4. Not all exchange-traded funds are inexpensive:
While it’s not totally wrong, it’s also not totally accurate
to associate ETFs with low costs.
It is crucial to use caution. It is not always the case that funds with the
term ETF in their name have low fees. Before selecting one to invest in, you
should compare any ETFs that are available for the index or theme you wish to
invest in. ETFs that replicate comparable indexes may also be worthwhile to
include in your comparison.
5.Risk to the other party:
We need to recognize that, in reality, not all ETF managers
buy the underlying assets. Some exchange-traded funds (ETFs) mimic an index or
other benchmark using swaps. In a swap, a third party provides the operator of
the ETF with the returns and dividends determined by the benchmark. The ETF
pays a fee for the service and provides collateral in return. The checklist for
choosing an ETF contains additional information about mimicking techniques.
If one of the two parties involved in the swap goes
bankrupt, as an investor you will bear counterparty risk. In the worst case,
you could lose your entire investment. However, the actual likelihood of this
happening is low, partly because regulations greatly reduce the risk.
6.The potential for loss still remains:
Unlike investing in a small number of individual stocks, it
is true that having a globally diversified stock portfolio – for example, using
ETFs – significantly reduces the risk of loss. However, this does not eliminate
the possibility of financial loss. Losses can never be completely ruled out,
and returns can never be guaranteed. Future returns cannot be predicted. There is no guarantee that past performance will predict future performance.