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What are ETF (Exchange traded funds)? How to invest in ETFs?

Updated on February 21, 2016

What are ETF (Exchange traded funds)? How to invest in ETFs?

An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, similar to stocks. An ETF holds an underlying asset such as a stock, commodity, bond, currency or Gold. Simply put, they are like a basket of securities. People can buy ETFs and trade them like stocks. You could invest in various ETFs based on market situation. For example, when the market is strong, you could buy ETFs based on currency or stocks. When the market is dull, you could choose to invest in safe instruments such as Gold. Similarly, people who wish to invest in Gold for its value but do not wish to hold physical Gold can also invest in ETFs. Gold ETFS are fast becoming popular in India. Like stocks, ETFs are like capital assets and one can borrow loans against them.

Most ETFs track an index, such as a stock index or bond index. An ETF will invest in stocks that comprise an index. When the composition of the index is changed, the ETF will incorporate the same in its portfolio. When the returns and price movements of an index changes, the same will be reflected in the ETF portfolio

Benefits of ETFs: ETFs reduce market risk for the investor. You can diversify your investment portfolio using ETFs. It is particularly useful for young investors who may not have huge funds for investment. ETFs enable one to have a diversified investment portfolio with low investment. Similarly, related expenses are low. For example, there is no fund manager fee. ETFs are very liquid and they are traded through the day much like stocks. This liquidity feature enables ETFs to be used for intraday trading.

One of the greatest advantages of ETFs over stocks is that you could invest in a particular sector instead of a particular company. For example, if you feel that energy sector is bound to grow but you are unsure about the individual prospects of companies, you could buy into the sector rather than a specific stock. If you lack industry knowledge or knowledge about a particular company, ETF is the better choice than stocks.

Tax Saving advantage: ETFs are efficient than Mutual funds as far as tax saving is concerned. All capital instruments like ETFs and Mutual funds will have to pay capital gains tax. But since ETFs don’t necessarily have to sell the underlying asset to finance investment inflows and outflows, they will distribute far less in capital gains each year than a mutual fund.

How to start trading in ETFs: You will need a Demat account to start trading in ETFs. An investor can buy or sell on the exchange without approaching the fund house. Today, public sector banks like SBI are dealing with ETFs and therefore you could approach them directly. Like Mutual funds, an ETF will be assigned a NAV (Net asset value). ETFs are available to retail investors in multiples of one unit.

Drawback: If you are interested in speculation and willing to take risk, stocks may be a better option for you than ETFs. If you have time to study the market and obtain industry knowledge, you could choose stocks as these will give higher returns than ETFs.

Popular ETFs in India: Some of the popular ETFs in India are SBI-ETF Gold, Birla Sun Life Gold ETF, HDFC Nifty ETF, Kotak Nifty ETF, ICICI Prudential Nifty ETF etc


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    • JvicIndia profile image

      John 19 months ago from India

      US based firm First Trust has planned to launch ETF on Newyork Stock Exchange (NYSE) to provide exposure to top 40 listed companies in the country

    • JvicIndia profile image

      John 23 months ago from India

      Hope the above ETF guide is useful to everyone....