Understanding common NIFTY ETF myths

ETFs, short for Exchange Traded Funds, are a type of investment option where money from investors is pooled to buy different tradable financial assets, including bonds, shares, and physical assets. ETFs are traded just like shares on the stock exchange. They offer a combination of the trading flexibility of stocks and the diversification of mutual funds. Moreover, if a particular ETF tracks a market index like Sensex or Nifty, it can offer broad market exposure, too.

Nifty ETFs have been popular among Indian investors for quite a few years now, especially post the COVID-19 pandemic. However, higher popularity has also led to the spreading of misinformation about them.

Let’s debunk the most common Nifty ETF Myths together.

• Table of contents

1. Nifty ETFs are riskier.
2. A good ETF replicates the index.
3. A bigger index offers greater diversification.
4. All Nifty ETFs have a low expense ratio.
5. Nifty ETFs are not ideal for beginners

Nifty ETFs are riskier.

Reality: While the exact classification of asset classes may vary from one ETF to another, ETFs offer the same level of diversification as other types of mutual funds. The risk factor in a Nifty ETF or a mutual fund depends on the nature of underlying exposure. Investors can choose the ETF based on their degree of risk tolerance.

A good ETF replicates the index.

Reality:This is also one of the most widely spread Nifty ETF investment myths. The reality is that the index is a theoretical concept, and it is not feasible to completely replicate the index because of a fund’s expenses and cash balance. The inflows and outflows in the ETF can create divergences from the index. However, investors can ignore nominal divergences but be vigilant when they spot high tracking differences/ errors.

A bigger index offers greater diversification.

Reality: This is another Nifty ETF myth. In theory, a Nifty 100 ETF offers more diversification than a Nifty 50 ETF, while a Nifty 500 ETF offers more diversification than a Nifty 100 ETF. Does this mean a Nifty 500 ETF is the best among the three? The simple answer is, ‘no’. If you invest in a Nifty 100 ETF instead of a Nifty 50 ETF, you will get 50 additional stocks, but the top 50 stocks may hold a larger chunk in the basket. According to recent data, the top 50 stocks account for 84% of the basket. Therefore, diversifying beyond a point does not lower the risk. Even if you get more stocks beyond this threshold, the benefits of diversification dwindle.

All Nifty ETFs have a low expense ratio.

Reality: This is one of the easiest Nifty ETF investment myths to bust. While expense ratios of ETFs are usually quite low, they are not always the lowest when you compare them with other funds. The expense ratio should not be the biggest deciding factor when it comes to picking a Nifty ETF anyway. Instead, you should consider the liquidity factor, performance divergence from the index, diversification and risk exposure while choosing a Nifty ETF to invest in.

Nifty ETFs are not ideal for beginners.

Reality: You would be surprised by how many investors do not invest in ETFs because they think ETFs are not suitable for them and carry a higher level of risk than mutual funds. However, the fact is that ETFs offer the same level of diversification as mutual funds and different types of ETFs carry a different level of risk. Investors can choose the Nifty ETF that is suitable for them based on their objectives and risk appetite.

In conclusion, Nifty ETFs are suitable for most Indian investors. They can place stop-loss orders, limit orders and so on since ETFs are traded like stocks. The good part is that investors can buy and sell them at any time of the day. Additionally, ETFs report their holdings on a daily basis which helps maintain transparency. You can consult with your financial advisor to help pick the right Nifty ETF for you.

FAQs:

Are NIFTY ETFs riskier than individual stocks?

No, NIFTY ETFs provide diversification by tracking an index of multiple stocks, reducing individual stock risk. However, like any investment, they carry market risk, but it's spread across the index.

Can NIFTY ETFs only be bought and sold during trading hours?

Yes, NIFTY ETFs can be traded like stocks during market hours. However, their prices may fluctuate after hours due to underlying asset changes.

Do NIFTY ETFs require a Demat account?

Yes, to invest in NIFTY ETFs, you need a Demat account as they are held in electronic form, like stocks and securities.

Are NIFTY ETFs only for experienced investors?

No, NIFTY ETFs are suitable for both beginners and experienced investors looking for diversified exposure to the stock market with lower fees.

Do NIFTY ETFs guarantee return like fixed deposits?

No, NIFTY ETF returns are subject to market performance and don't offer fixed returns. They're designed for long-term growth and align with market trends.

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.