What are the benefits of investing in an ETF?

Exchange Traded Funds (ETFs) are funds that track a financial market index and are traded on stock exchanges. They can combine the diversification potential of mutual funds with the flexibility and opportunities of securities trading and provide investors with a diverse and relatively low-cost way to gain exposure to the financial market. Below are some ETF investment benefits.

• Table of contents

1. Diversification
2. Low cost
3. Transparency
4. Liquidity
5. Flexibility
6. Performance advantage
7. Easy to trade

Diversification

One of the biggest advantages of ETFs, especially over individual stocks, is diversification through just one investment avenue. ETFs contain a basket of securities from a particular index or sector, allowing investors to gain broad exposure with a single investment. For example, a Nifty 50 ETF would contain all the 50 constituent stocks of the Nifty 50 index.

While investors would otherwise independently have to independently curate a basket of individual stocks to achieve diversification, an ETF investment provides diversification across the underlying sector or index. This can potentially mitigate risk as the fate of your investment does not depend on the performance of just a few stocks. Thus, ETFs make diversification simple and easy.

Low cost

ETFs have relatively lower expenses compared to mutual funds, especially actively managed ones. ETFs, especially passively managed ones, aim to match the returns of an index, subject to tracking error. The fund manager does not need to actively pick stocks or time the market – instead the portfolio comprises of a proportionate representation of the stocks in the index. This passive style of management results in lower operating costs.

ETF expense ratios are generally below 1%, whereas active mutual fund fees can be 1.5-2.25% or higher. Hence, ETFs can be a cost-effective way to invest in different market segments.

Transparency

ETFs disclose their complete portfolio holdings every day. Investors can easily analyse the stocks, bonds or assets held by the ETF. In contrast, mutual funds, including index funds, reveal their holdings periodically. The transparency of ETFs allows investors to know exactly what their portfolio encompasses on a daily basis.

Liquidity

ETFs trade on the stock exchanges just like regular stocks. Their liquidity is a major advantage over other mutual funds. Investors can buy and sell ETFs instantly during market hours. The intraday trading and liquidity make ETFs ideal for implementing trading strategies such as hedging. This also gives investors greater flexibility to benefit from real-time market movements at the time of redemption. With mutual funds, in comparison, the units can only be redeemed at the NAV calculated at the day’s end. This could potentially cause an investor to lose out.

Flexibility

There are ETFs available for all asset class that have corresponding indices – equities, bonds, gold, real estate etc. Investors can use ETFs to gain exposure to markets and sectors that may otherwise be difficult to access, like overseas stocks. You can choose a sector-specific ETF or a diversified one based on your investment objective.

Performance advantage

ETFs minimise costs and avoid excessive trading that can erode returns while providing broad market exposure. Because a majority of them are passively managed, this also reduces the room for managerial error – the risk of a portfolio underperforming because of calls taken by the fund manager. This is another one of the potential ETF investment benefits.

Easy to trade

Investing in ETFs is as easy as buying shares through your brokerage account. You can place orders online just like for stocks. Thus, ETF investments are good for beginner investors who do not want to independently create a diverse portfolio of shares but still want the liquidity and opportunities for real-time trade that the stock market provides.

Conclusion

ETFs are a suitable way for investors to build diversified, low-cost portfolios across various asset classes. They can offer higher liquidity, flexibility, and transparency than some types of mutual funds. ETFs make accessing markets and implementing asset allocation convenient for both new and sophisticated investors. For example, the Bajaj Finserv Nifty 50 ETF tracks the Nifty 50 index and offers investors access to a basket of India's top 50 companies in one single transaction, providing an easy way to achieve diversification at relatively low costs.

FAQs:

What are the risks of investing in ETFs?

ETFs are exposed to market risk and can experience volatility in line with wider market movements. Also, the performance and net returns from an ETF may deviate slightly from the underlying benchmark index due to fees and other factors, which is known as tracking error.

How are ETFs taxed in India?

Equity ETFs attract similar tax treatment as equity shares. Short-term capital gains under 1 year are taxed at 15%, while long-term capital gains over 1 year are taxed at 10% beyond the Rs. 1 lakh annual exemption limit.

What are the different types of ETFs available?

Equity ETFs track stock indices and allow investors to gain exposure to domestic or global markets. Debt ETFs provide access to fixed income assets like government and corporate bonds. Other varieties include gold, currency and sector-specific ETFs that target narrow industries, international markets, commodities, or strategies using leverage.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as 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 purpose 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.