| An ETF is a basket of securities that is traded on the stock exchange, just like a stock. So, ETFs are listed on a recognised stock exchange. Their units can be bought and sold directly on the exchange, through a stockbroker during the trading hours. ETFs can be either close-ended or open-ended. Open-ended ETFs can issue fresh units to investors even post the new fund offer stage.ETFs can be either actively or passively managed. In an actively-managed ETF, the objective is to outperform the benchmark index. On the contrary, a passively-managed ETF attempts to replicate the performance of a designated benchmark index. Hence it invests in the same stocks, which comprise its benchmark index and in the same weightage. For example, Nifty BeES is a passively managed ETF with the S&P CNX Nifty being its designated benchmark index. When you buy or sell a stock, you are basing your transaction on the predicted performance of one company. When you buy or sell an ETF, you are basing your transaction on the predicted performance of multiple companies.When you buy or sell an index, you are actually buying shares in individual companies. With an ETF, you are buying shares in a portfolio of those companies. So, if you had an opinion about a certain company in the index basket, you could make an adjustment by selling or buying shares of an individual equity (although, this is not common). With an ETF, you cannot adjust the individual equities in the portfolio. ETF units are continuously created and redeemed based on investor demand. Investors may use ETFs for investment, trading or arbitrage. The price of the ETF tracks the value of the underlying index. This provides an opportunity to investors to compare the value of underlying index against the price of the ETF units prevailing on the stock exchange. If the value of the underlying index is higher than the price of the ETF, the investors may redeem the units to the asset management company that sponsors the ETF in exchange for the higher priced securities. Conversely, if the price of the underlying securities is lower than the ETF, the investors may create ETF units by depositing the lower-priced securities. This arbitrage mechanism eliminates the problem associated with closed-end mutual funds viz. the premium or discount to the NAV. ETFs are not MFs You may get confused between ETFs and conventional mutual funds. However, they are different on several counts. The only similarity between ETFs and conventional mutual funds is that they both provide you an opportunity to invest in a variety of stocks/instruments through a single instrument. When you invest in a mutual fund, you need to buy and sell units from the fund house. Since buying and selling of ETFs is done on the stock exchange, the transaction has to be routed through a broker. If ever you can buy or redeem units in an ETF through the fund house, it is normally done in a pre-defined lot size. Typically, the lot size tends to be substantial making it feasible only for institutional investors and high networth individuals. Since ETFs are traded on the stock exchange, they can be bought and sold at any time during market hours like a stock. This is known as ‘real time pricing’. In contrast, mutual funds can be bought and redeemed only at the relevant NAV; the NAV is declared only once at the end of the day. As a result, you have the opportunity to make the most of intra-day volatility in case of ETFs. This may not hold much significance if you are a long-term investor. Mutual funds are always available at end-of-day NAV, whereas ETFs do not necessarily trade at the NAV of their underlying portfolio. In fact, the market price of an ETF is determined by the demand and supply of its units, which in turn is driven by the value of its underlying portfolio. But in case of a close-ended ETF the price remains fixed. Therefore, the possibility of an ETF trading below (at a discount) or above (at a premium) its NAV does exist. |
FAQs
ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.
Are ETFs good for beginners? ›
The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.
What is ETF basics for beginners? ›
What is an ETF? An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once. Investors buy shares of ETFs, and the money is used to invest according to a certain objective. For example, if you buy an S&P 500 ETF, your money will be invested in the 500 companies in that index.
How does an ETF make you money? ›
Most ETF income is generated by the fund's underlying holdings. Typically, that means dividends from stocks or interest (coupons) from bonds. Dividends: These are a portion of the company's earnings paid out in cash or shares to stockholders on a per-share basis, sometimes to attract investors to buy the stock.
What is the best way to explain ETF? ›
An exchange-traded fund, or ETF, is a basket of investments like stocks or bonds. Exchange-traded funds let you invest in lots of securities all at once, and ETFs often have lower fees than other types of funds. ETFs are traded more easily too. But like any financial product, ETFs aren't a one-size-fits-all solution.
What is the downside to an ETF? ›
At any given time, the spread on an ETF may be high, and the market price of shares may not correspond to the intraday value of the underlying securities. Those are not good times to transact business. Make sure you know what an ETF's current intraday value is as well as the market price of the shares before you buy.
What do you actually own when you buy an ETF? ›
There is no transfer of ownership because investors buy a share of the fund, which owns the shares of the underlying companies. Unlike mutual funds, ETF share prices are determined throughout the day. A mutual fund trades only once a day after market close.
How many ETFs should I own as a beginner? ›
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
How much should I invest in an ETF for the first time? ›
You can put $500 in a stock ETF and $500 in a bond ETF to achieve a diversified two-asset-class portfolio which, though simple, can be a great start toward building a portfolio appropriate for your goals. ETFs can be a simple way to build incrementally toward your long-term plan.
Do you pay taxes on ETFs if you don't sell? ›
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
In order to withdraw from an exchange traded fund, you need to give your online broker or ETF platform an instruction to sell. ETFs offer guaranteed liquidity – you don't have to wait for a buyer or a seller.
What is the primary disadvantage of an ETF? ›
ETF trading risk
Spreads can vary over time as well, being small one day and wide the next. What's worse, an ETF's liquidity can be superficial: The ETF may trade one penny wide for the first 100 shares, but to sell 10,000 shares quickly, you might have to pay a quarter spread.
Should I just put my money in ETF? ›
ETFs can be a great investment for long-term investors and those with shorter-term time horizons. They can be especially valuable to beginning investors. That's because they won't require the time, effort, and experience needed to research individual stocks.
Is it better to invest in stocks or ETFs? ›
Stock-picking offers an advantage over exchange-traded funds (ETFs) when there is a wide dispersion of returns from the mean. Exchange-traded funds (ETFs) offer advantages over stocks when the return from stocks in the sector has a narrow dispersion around the mean.
What is an ETF in layman's terms? ›
ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index.
How to choose an ETF for beginners? ›
Before purchasing an ETF there are five factors to take into account 1) performance of the ETF 2) the underlying index of the ETF 3) the ETF's structure 4) when and how to trade the ETF and 5) the total cost of the ETF.
Should I start investing in ETFs? ›
For most individual investors, ETFs represent an ideal type of asset with which to build a diversified portfolio. In addition, ETFs tend to have much lower expense ratios compared to actively managed funds, can be more tax-efficient, and offer the option to immediately reinvest dividends.
