Should you consider investing in ETF?
Exchange-traded funds (ETFs) are a basket of securities that are designed to mirror a specific stock market index. They are similar in structure to index funds but are traded on stock exchanges like shares.
These funds offer potential benefits such as easy diversification and relatively lower expenses for investors seeking a return potential in sync with the broader market conditions that minimises the influence of a fund manager’s decision-making and strategy. Returns are similar to the benchmark subject to tracking error.
In this article, we will explore the key differences between ETFs and mutual funds, things to know before investing in ETFs and some ETF strategy examples.
- Table of contents
ETF vs mutual funds: key differences
ETFs differ from regular mutual funds on a few important parameters:
- Trading: ETFs are traded on stock exchanges and allow intraday trading, enabling investors to potentially capitalize on short-term market movements. Mutual fund units can be bought or sold only at the end of each trading day at the prevailing Net Asset Value (NAV).
- Calculation of NAV: The NAV of mutual funds is calculated at the end of each trading day. Since ETFs permit intraday trading, they may trade at a premium or a discount to their end-of-day NAV. So, ETFs also have an iNav (indicative NAV or intra-day NAV) that is updated several times in a minute.
- Diversification: Both ETFs and mutual funds offer diversification benefits. However, ETFs and index funds could provide wider diversification within one investment, especially if they are pegged to a broad-market index.
- Costs: Being passively managed, ETFs generally have lower expense ratios as compared to actively managed mutual funds.
Things to know before investing in ETFs
Before investing in ETFs, it’s crucial to understand your objectives, risk profile, preferred ETF investment strategy, and liquidity requirements. Here’s a brief overview of each factor:
- Objectives: Clearly define your investment objectives. ETFs may be suitable for investors who want a passive investing style, returns that mirror broader market trends, the opportunity for intra-day trading, and relatively high liquidity. Within ETFs, investors may prefer an equity, debt, or hybrid fund depending on their investment horizons and goals.
- Risk profile: Assess your risk tolerance and choose an ETF that aligns with it. For example, ETFs that invest in debt securities may be more suitable for investors with a lower risk appetite, while equity-oriented ETFs may be considered by investors with a higher risk profile who are seeking potential capital appreciation over the long term.
- Investment style: Passive investors may find the index-oriented nature of ETFs appealing as it allows for a buy-and-hold approach. Active investors or financially savvy investors too may be attracted to the day-trading feature offered by ETFs, which allows for tactical asset allocation strategies and the potential to benefit from brief market movements.
- Cost and transparency: Passive ETFs aim to replicate the performance of an index, subject to tracking error, rather than relying on fund managers for active stock selection. This can significantly lower the expense ratio of the scheme. Moreover, ETFs must disclose their holdings on a daily basis, providing investors with more transparency into the portfolio composition.
Conclusion
ETFs offer several potential benefits, including diversification, flexibility, and cost-effectiveness. However, it's crucial to understand your objectives, risk profile, preferred ETF investment strategy, and liquidity requirements before investing in ETFs. It is also prudent to have a robust ETF buying strategy before making an investment. It is recommended that investors consult a financial advisor for tailored investment advice.
FAQs:
Are ETFs a suitable investment for beginners?
Yes, some ETFs can be a suitable investment for beginners due to their low costs, diversification benefits, and passive investment approach. However, it is essential for beginners to conduct thorough research and seek professional advice before investing.
Can ETFs be used for short-term trading?
Yes, ETFs can be used for short-term trading due to their intraday liquidity and ability to capture market movements. However, it is important to note that short-term trading involves higher risks and requires active monitoring of market conditions.
How do I determine the best ETFs for my investment needs?
To determine the best ETFs for your investment needs, consider factors such as expense ratios, performance history, underlying assets, and the fund manager's track record. Conducting thorough research and consulting with a financial advisor can help you make informed investment decisions.
Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as an endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purposes only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals, and horizon. This information is subject to change without any prior notice.