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If you are thinking of investing and looking for new options, then ETFs (Exchange Trading Funds) can be a good option. What are ETFs, how do ETFs work, how many types of ETFs are there, what is the difference between ETFs and mutual funds, how to trade in ETFs. You are going to get answers to all these questions today.
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| ETFs |
What is ETF? An Overview
Every person should think about investment and start investing very soon. Many people invest in direct stocks, many people invest through mutual funds but there are very few people who invest through ETFs. Most people do not know what ETFs are. ETFs (Exchange Trading Funds) are a popular investment option that provides an easy way for individuals to invest in a diversified portfolio of assets.
ETFs are a type of investment fund that, like stocks, are traded on exchanges. ETFs are somewhat similar to mutual funds but there are some key differences that make ETFs a unique investment option.
- ETFs are traded like stocks: You can trade in ETFs just like you buy and sell stocks during the day. On the other hand, mutual funds trade only at the end of the day when net asset value (NAV) is calculated.
- ETFs are passively managed: Most ETFs are built to track a specific index such as the Nifty 50, S&P 500 or the NASDAQ. This means that the fund manager determines the holding of the fund in ETFs on the basis of that index instead of investing in individual stocks.
- ETFs are cost efficient: The expense ratios in ETFs are lower as compared to mutual funds. making ETFs attractive to investors looking to reduce costs.
- ETFs are Tax efficient: The way ETFs are designed, the capital gains distribution is less as compared to mutual funds. This means investors can keep more of their returns.
How Do ETFs Work?
ETFs usually collect money from investors to buy a diversified portfolio of assets. The fund's holdings are determined by the index it tracks, which means that the fund's performance will generally mirror the performance of the index.
When you invest in an ETF, you are buying a share of that fund. ETF prices are determined by the market and can fluctuate throughout the trading day. ETFs are open-ended funds, which means the fund can issue new shares if demand for the ETF increases. ETFs can increase or decrease their size if needed.
How Many Types of ETFs are?
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| Exchange Trading Funds |
1. Equity ETFs: These ETFs invest in stocks and are created to track a specific index like Nifty 50, Nasdaq, S&P 500. Equity ETFs can be classified into large Cap, midcap, small cap stocks. This gives investors an opportunity to invest at different levels.
2. Bonds ETFs: These ETFs invest only in bonds. Bond ETFs track a specific bond index like LIC Nomura AMC. Bonds ETFs invest in fixed income securities such as corporate bonds, government bonds and municipal bonds.
3. Commodity ETFs: Commodity ETFs invest in physical commodities such as gold, silver, oil, minerals, metals and agricultural products.
4. Currency ETFs: Investing in currency ETFs is done to avoid fluctuations in foreign currencies. Currency ETFs are used for hedging.
5. Sector ETFs: Stock market is divided into different sectors like health care sector, technology sector, energy sector, banking sector, fmcg sector etc. Sector ETFs invest in these sectors instead of investing in individual stocks of these sectors.
Difference Between ETFs and Mutual Funds
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| Mutual Funds |
TRADING
You can buy and sell ETFs like stocks during the business day. ETFs prices keep fluctuating. Mutual funds are bought at the end of the trading day based on the price determined by the net asset value (NAV) of the fund.
EXPENSE RARTIO
The expense ratio of ETFs is lower than that of mutual funds. This is because ETFs are passively managed and are priced by tracking a specific index. While there are professional teams to manage mutual funds, whose aim is to beat the market by taking appropriate decisions.
TAX EFFICIENCY
ETFs generally offer more tax benefits than mutual funds. ETFs usually have lower capital gains distributions because they have fewer transactions, and investors can sell ETFs without triggering capital gains taxes.
FLEXXIBILTY
You can do intraday trading in ETFs. Short sell and options trading can also be done in many ETFs. Whereas mutual funds can be bought or sold at the end of the day. There is no trading option in mutual funds. That's why ETFs are more flexible than mutual funds.
Minimum investment
ETFs require low minimum investment. While many mutual funds may require an initial investment of several thousand dollars.
ETFs
PROS CONS Lower expense ratios
Prices can be volatile.
Greater tax efficiency
May trade at a premium or discount to their net asset value
Easy tradability
Limited active management
Flexibility in trading
Lower minimum investment requirements
Lower expense ratios
Prices can be volatile.
Greater tax efficiency
May trade at a premium or discount to their net asset value
Easy tradability
Limited active management
Flexibility in trading
Lower minimum investment requirements
Mutual Funds
PROS | CONS |
|---|---|
Professional management | Higher expense ratios |
Offer a wider range of investment options | Can only be bought and sold at the end of the trading day. |
Greater diversification | Limited trading flexibility |
Access to institutional share classes | Higher minimum investment requirements |
Difference Between ETFs and Equity Funds
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Equity Funds |
TRADING
One of the primary differences between ETFs and equity funds is how they are traded. ETFs are traded on an exchange like a stock, which means you can buy and sell shares throughout the day. Equity funds, on the other hand, are only traded once per day after the market closes. This means that if you want to take immediate profit, then you can trade in ETFs.
FEES
Fees are also an important difference between ETFs and Equity Funds. ETFs do not require fund managers, due to which the cost of investing in ETFs comes down. Whereas Equity Funds are actively managed by the Fund Manager. Due to which the cost of equity fund increases.
Transparency
ETFs are known for their transparency as ETFs are traded in the market throughout the day, so investors know at what price they are investing or trading in ETFs. While mutual funds are not required to disclose their funds on a daily basis.
TAX EFFICIENCY
When you are selling shares of ETFs on the exchange, it means that you are selling them to another investor. In this the fund is not generating capital gains. This can help in reducing your tax liability.
Equity funds, on the other hand, are structured as mutual funds. When you sell shares of an equity fund, the fund itself may generate capital gains, which can be taxable. Additionally, because equity funds are actively managed, they may have a higher turnover rate, which can also generate more capital gains.
MINIMUM INVESTMENT
ETFs typically have lower minimum investments than equity funds. This means that you can start investing in an ETF with a smaller amount of money than you would need to invest in an equity fund.
TRADING FLEXIBILTY
ETFs are always available to trade during market hours. You can buy or sell them at any time. On the other hand, equity funds trade once per day after the market closes. This means that you cannot trade throughout the day, which can be a disadvantage if you are looking to take advantage of short-term market movements.
ACTIVE MANAGEMENT
Equity funds are managed by professional fund managers. This means that the fund manager, with his discretion and experience, decides which stock to buy or sell.
ETFs, on the other hand, are typically passively managed. This means that they track an index or a specific market segment, and the fund manager doesn't make individual stock selections. While this can be an advantage in terms of cost, it means that you don't have the benefit of a professional fund manager making investment decisions on your behalf.
FAQs
1. Which is Better ETFs or Equity Funds?
You have the answer to this question only. You decide your financial goals and then see whether it is more appropriate to invest in ETFs or equity funds.
If you're looking for low-cost diversification, ETFs can be a great option. If you want the benefit of a professional fund manager making investment decisions on your behalf, then an equity fund may be a better fit.
2. Do ETFs pay dividends?
yes, some ETFs dividends, while others do not. Bond ETFs and dividend ETFs are more likely to pay dividends.
3. Are ETFs suitable for long-term investing?
yes, ETFs can be suitable for long-term investments as they offer diversification and low expense ratios. so, it's important to choose right ETFs that aligns with your long-term investment's goals and risk tolerance.
4. Are ETFs better than Mutual Funds?
Both ETFs and Mutual Funds have their own advantages and disadvantages. Where the cost of investing in ETFs is low, can be traded like shares, tax benefits are also available. On the other hand, Mutual Funds provide a professional management. And from small to large may be better for continuous investment.
5. Are ETFs Risker Than Equity Funds?
Both ETFs and Equity Funds carry the same level of risk. However, ETFs are generally considered less risky than individual stocks because they offer diversification. Additionally, because ETFs are passively managed, they tend to be more stable than equity funds.
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