Exchange-Traded Funds (ETFs) were introduced in the USA in 1993, marking the beginning of their global popularity. The first ETF launched in India was Nifty BeEs in 2002, tracking the Nifty benchmark index. Since its inception, Nifty BeEs has demonstrated impressive growth, boasting a remarkable absolute return of 1914.15%.
Despite the widespread awareness of stocks and mutual funds among investors, ETFs remain relatively less understood in the investment community. This article serves as a beginner’s guide to ETFs, providing essential information to help investors navigate this increasingly popular investment option.
What are ETFs?
Full form of ETF is Exchange-Traded Fund which shares similarities with traditional mutual funds but possesses distinct characteristics that set it apart. While both collect funds from investors, are managed by professionals, and have a Net Asset Value (NAV), ETFs have two unique features:
ETFs are traded on stock exchanges, unlike regular mutual funds which are not. This means investors can buy and sell ETFs throughout the trading day at market prices, just like stocks.
ETFs are passive investments that typically track benchmark indices such as the Nifty or Sensex. Fund managers of ETFs purchase stocks of the benchmark index constituents, aiming to replicate index returns closely.
Since ETFs are listed on stock exchanges, investors can trade them using their stockbrokers, similar to buying and selling individual stocks. This liquidity and accessibility make ETFs a popular choice among investors seeking diversified exposure to various market segments.
Now, let’s explore the different categories of ETFs.
Equity ETFs:
These ETFs aim to replicate the performance of specific stock indexes or groups of stocks within a particular industry or sector. The objective of these ETFs is to closely mirror the returns of their benchmark index or the performance of a specific sector. By investing in these ETFs, investors gain exposure to the overall performance of the index or sector without needing to purchase individual stocks.
Gold ETFs
Investing in gold is often viewed as a hedge against currency volatility and economic downturns. However, purchasing physical gold presents various challenges such as security concerns, assessing quality, difficulties in resale, and tax implications. Gold ETFs, or exchange-traded funds, offer a convenient alternative by investing in gold bullion. These ETFs enable investors to include gold in their portfolio without the complexities associated with owning physical gold.
ETFs with International Exposure
Certain ETFs replicate the performance of foreign stock indexes, granting investors exposure to international markets and enabling them to capitalize on the growth potential of specific economies.
Debt ETFs
Debt ETFs offer a means to invest in fixed-income assets and are actively traded on the NSE (National Stock Exchange). Compared to debt mutual funds, debt exchange-traded funds (ETFs) typically feature lower expenses.
Advantages of Investing in ETFs
Diversification: ETFs offer a convenient way to diversify your stock investments. Instead of picking individual stocks, investing in an ETF that tracks a sector or asset class provides exposure to a broader range of assets, strengthening your portfolio’s diversification.
Ease of Trading: Similar to shares, ETFs can be easily traded on stock exchanges, offering liquidity and flexibility to investors.
Market-Based Pricing: ETF units are traded at market values, allowing investors to benefit if market sentiment favors the sector or market that the ETF tracks.
Intraday Trading: ETF units can be bought and sold throughout the trading day, providing investors with the flexibility to execute trades at their convenience.
Lower Expense Ratio: ETFs typically have lower expense ratios compared to many traditional mutual funds, especially actively managed ones. This can result in cost savings for investors over the long term.
How to choose an ETF?
ETF Category: Begin by determining the ETF category that aligns with your investment objectives, such as equity, gold, international exposure, or debt. Research the sub-categories within your chosen category to narrow down your options.
ETF Trading Volume: Assess the liquidity of the ETF by examining its trading volume. While most ETFs now have sufficient liquidity for easy buying and selling, it’s essential to avoid those with low trading volumes, as they may pose challenges when executing transactions.
Expense Ratio: Pay attention to the expense ratio of the ETF, as it directly impacts your returns. Opt for an ETF with a lower expense ratio compared to its peers to maximize your investment gains over time.
Tracking Error: Evaluate the tracking error of the ETF, which reflects the variance between the ETF’s returns and the index it aims to replicate. Choose an ETF with a minimal tracking error to ensure that it closely mirrors the performance of its underlying index.
By considering these four aspects, you can make informed decisions when selecting an ETF that suits your investment goals and preferences.
