Exchange-Traded Funds or ETFs have emerged as a popular investment option alongside mutual funds in the Indian market in recent years. ETFs work like index funds and track the performance of predefined market indices. Some key advantages include low costs, diversification, and intraday tradability. Let’s understand the basics of ETFs and how to select the best-suited ones.
Choose an underlying index
The first step is deciding the type of index an ETF will track – Nifty50, global indices like S&P 500, etc. The selection depends on the investor’s risk profile, investment horizon, and preference for sectors gaining prominence. Broad market index ETFs like NiftyBeES provide diversification while thematic ETFs piggyback specific sectors.
Research cost ratios
Low costs are a major ETF advantage as expense ratios typically don’t exceed 0.5% to 1% annually unlike most active mutual funds. Compare Total Expense Ratios (TER) of ETFs tracking the same index – the lower the better.
Consider liquidity factors
ETFs are traded like stocks and adequate trading volumes on stock exchanges ensure ETF units can be easily bought and sold anytime throughout the day. Track minimum creation unit size (CUS) norms followed by participating market makers to maintain an adequate supply-demand balance to ensure you are investing in ETFs with high liquidity.
While domestic indices give domestic market exposure, international ETFs open doors to developed and emerging economies globally. Sector ETFs cater to focused themes. For hedged returns, consider currency-hedged ETF categories.
Top fund houses offer a range of ETF choices. Consider the track record, scheme metrics, and latest launches. Exchange research tools validate trading efficiency. The Securities and Exchange Board of India (SEBI) regulates ETF marketing ensuring uniformity.
Benefits of investing in ETFs
ETFs provide several benefits that make them an attractive investment option. Firstly, they offer instant diversification through a single instrument as ETFs represent a basket of various stocks from different companies across sectors and industries. This diversification helps reduce stock-specific risk for investors.
Secondly, ETFs have much lower expense ratios compared to actively managed mutual funds since they do not require active research and management of the underlying stocks. The low costs allow higher returns to compound over the long term. Furthermore, ETFs are passively managed instruments with complete transparency regarding their constituents and weights which track a predetermined index. Investors can easily understand the strategy and track performance.
Additionally, trading in ETF units is permitted throughout the day on stock exchanges, offering flexibility of entering and exiting at any pointy, unlike mutual funds where transactions are allowed at end-of-day NAV only. Lastly, investments in equity ETFs held for over one year qualify for long-term capital gains tax making them a tax-efficient vehicle, while distributions from ETFs are also tax efficient versus dividends from individual stocks.
Careful selection of low-cost ETFs tracking broad-based local and global indices with good liquidity and diversification provides benefits of low-risk passive investing. Long-term holds enable wealth growth riding index returns. Periodic reviews ensure chosen ETFs continue meeting criteria over changing market environments.