Things to know before investing in ETFs

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What are ETF Funds?

An Exchange Traded Fund or ETF is a form of passive investment fund which is very similar to a mutual fund, however, with the following exceptions:

  • It usually tracks an index, meaning it provides returns that are broadly in sync with the returns of the underlying index.
  • It is a liquid investment instrument, which means it can be bought and sold at market prices on the stock exchanges.

As ETFs are pooled funds, their underlying portfolio can comprise of shares, bonds, forex instruments, money market instruments, commodities, etc. There are a variety of ETF schemes available currently in the market.

While Exchange Traded Funds are quite popular in the international markets, In India, ETFs’ adoption is comparatively low. As per a December 2020 report by financial daily Financial Express, there are more than 2,000 ETFs managing more than $4 trillion across asset classes in the US. In comparison, there are around 90 ETFs managing over Rs. 2 trillion across asset classes in India.

However, with that being said, ETF investments have definitely seen a growth in India as indicated by an industry trends report by Association of Mutual Funds in India (AMFI). There has been a significant increase in ETF market share, from 7.1% in June 2020 to 9.9% in June 2021.

As the ETF landscape becomes more vivid, you as an investor might be tempted to use this investment tool as a step towards wealth creation. Before you dive deeper into it, here a few things you need to know.

Pros and cons of investing in ETFs

ETFs present many benefits like:

  • ETFs are a good choice of investment if you are looking to diversify your portfolio and minimise risks
  • ETFs report their holdings daily, offering a clear and current view of ongoing holding to the investors
  • ETFs also enable niche holdings as you can invest in specific sectors like energy, technology, real estate, etc. You can read more about investing in real estate ETFs in this article by Real Vantage to learn more. 
  • ETFs are highly liquid than non-listed funds like mutual funds and can be liquidated by holders at any time during trading hours

Though advantageous in many ways, they are certainly not completely free from limitations.

  • Buying and selling of ETFs results in trading fees. Depending on the number of times you trade the ETF, your miscellaneous charges can add up and affect the overall performance of your investment. Additionally, you need a Demat account to invest in ETFs
  • Due to a rare tracking error risk, ETFs sometimes may not accurately reflect the underlying index
  • Like most investment tools, they are subject to market fluctuations

Questions that need to be dealt with before you consider investing in ETFs

Below are some ETF questions that need to be answeredbefore investing:

Are ETFs risky?

ETFs are considered relatively low-risk investment tools as they are low cost and hold a basket of underlying securities that aid in the diversification of your portfolio. However, like most investment tools, they are subjected to systematic risks of investment based on the asset class and holding period.

What benefits do ETFs provide over other similar investment options?

ETFs have a long list of benefits over other similar options such as fewer expenses, tax efficiency, diversification, to name a few.

Do ETFs complement your investment plans?

It is imperative before selecting any plan to ensure that it aligns with your investment style and helps in achieving your long-term financial objectives. While investing, always make informed decisions and consult experts who have a thorough know-how of the investment landscape.

An expert can not only help in identifying opportunities and minimising risks, but can also help in creating a personalised investment plan that are aligned with your short-term and long-term goals and risk profile.

Get in touch with a financial advisor today and take your first step towards wealth creation.