What is an ETF?| Complete guide to ETF investment

Definition of exchange-traded funds(ETF) /what is an ETF?

Exchange-traded funds mean doing trade on cash market like Nifty, Sensex, Bank Nifty and other indices through a demat account. It is a fund which replicates a market and passively managed fund by asset management companies. We can't directly buy Indices like Nifty, Sensex, Bank Nifty, etc. ETF allows us to invest in the indices by replicating its performance. ETF can be bought like stocks from the trading markets.

What is ETF Investment in India?

ETF has not established much in India because of the developing nation tag. ETF performs much well in developed countries because the market there is developed and the indices show a steady performance. Indian markets are affected by very small factors or we can say it is a very reactive market which can go up or down anytime.

        Let's consider we want to trade on Nifty today so, nifty consists of top performing 50 companies which gives consistent returns over the year and each company has a particular percentage of share or presence in Nifty. 

        Let's say HDFC holds 9% share, Reliance holds 8% share, ITC holds 6% share, other 77% shares are held by 47 remaining companies. So when we invest in nifty through ETF, the fund manager will buy the stocks of the 50 companies according to their percentage of share. 

        If you are going to invest Rs. 1 lakh, so the fund manager will buy stocks of HDFC worth Rs.9000, Reliance stocks worth Rs.8000, ITC stocks worth Rs.6000 and the stocks of remaining 47 companies. 

The expense ratio of the ETF:

The expense ratio of ETF is 0.05% to 1% on the investment as of 09 DEC 2018. The ETF expense ratio is very less since the fund is passively managed by the fund house and you don't have to pay much for their manual investment labor. 

Advantages and disadvantages of ETF:

Advantages:

• Fewer management fees- Since ETF is passively managed by fund companies you don't have to pay high fees. It has less expense ratio than mutual funds. You only have to pay brokerage charges for a particular transaction. But if the number of transactions you do is high then it will have a heavy effect on your brokerage.

• Less risk- If you have knowledge about what you are doing, investing in indices has less risk because the indices mostly consist of consistent performing companies giving a constant return on your investments.

• Instant diversification- Since the investment is done in different sectors of companies, your investment is diversified decreasing your capital risk and chances of maximized profit are high.

• Government securities- As an individual person, you can't buy government securities like stocks from a market. But ETF acts as a medium for you to invest directly in such government securities.

• Buying/Selling- In mutual funds you can't buy or sell your units on a particular day. It almost takes more than 24 hours to withdraw your funds. In ETF you can buy or sell units multiple times in a day.

• Options- Since there are fewer options for you to invest, you can keep track of the performance of different indices you want to invest. This makes it easy for an investor to select the investment option he wants to make. 

Disadvantages:

• Less return- Some of the actively managed funds beats the returns than most of the indices because of these ETF gives less return compared to the actively managed funds.

• Brokerage charges- If you have a number of transactions in ETF then the cost of the brokerage charges can be more than the fees charged by the actively managed funds.

• Less popularity- Since the popularity of ETF is less in India some of the funds are held for a longer period of time decreasing the liquidity ratio. But as more people will come to know about ETF, the liquidity ratio will increase.

• Fewer options- Compared to the developed countries ETF in India has fewer options for investment.

Should we invest in ETF?

It is a very good option to invest in ETF if you have good knowledge about what you are doing. Since you are investing in the indices chances of profit are high. Less expense ratio which profits you in the long run. Diversified investment in consistent return giving companies. You can buy and sell your investment anytime. Since it's passively managed you benefit from some guidance.

Types of ETF:

• Equity- ICICI Prudential Nifty ETF(Nifty 50) | Kotak Banking ETF (Nifty Bank Index)

• Bond/Debt- LIC Nomura Long Term ETF

• Gold- Axis Gold ETF | Kotak Gold ETF

• Global Indices- Reliance ETF Hang Seng

Do ETF pay dividends?

ETF pays the investors full dividend that comes from the stocks. Most of the ETF pay the investors the dividend earned from the profit of the investment on a quarterly basis.

Is ETF safe?

If you have knowledge about the share market, how it performs then you can earn some nice profit from ETF. You should have knowledge about how and when to invest in indices. If you invest at the right time you will be making a huge profit on your investment. Since the movement of indices is less compared to a particular stock in the trading market you have a chance to limit your loss.

Can we reinvest the dividend in ETF?

Yes, you can reinvest the dividend but to do it is a complicated process, but you can do it manually by buying more units in ETF using the dividend you received.

How much tax we have to pay on ETF returns?

If you are holding the indices fund for less than a year than you have to pay short term capital gain tax of 15% on your profit. If you are holding the fund for more than a year than you have to pay no tax on your profit.

What is the difference between Mutual Fund and ETF?

1. Mutual Funds set price daily vs ETF trade all day.
2. In Mutual Funds, you can trade only once with your total investment vs an ETF you can sell and buy all day.
3. Mutual funds are actively managed by the fund house buying and selling to maximize your investment vs In ETF you are investing on a particular indices fund.
4. Mutual funds are bought through fund companies, broker or financial advisors vs ETF can be bought through Exchange.
5. Your investment in Mutual funds is managed by experienced people who study the market continuously so you don't have to worry about your investment vs In ETF you are more responsible for your investment.
6. In Mutual Fund you have to pay more because the expense ratio is more vs In ETF you are managing your own investment so you have to pay less.

Which is a better ETF or Mutual Fund?

Both has its own pros and cons. ETF gives you more flexibility in your investment. The Mutual fund is managed by professionals decreasing your risk factor. Diversified investment is possible in ETF. The responsibility of your Investment is high in ETF. It depends on how good you are in trading and your understanding of the market. The time factor is also crucial here. Do you have time to follow the performance of the market?

Is ETF better than stocks?

In stocks, you are buying a particular share of a company. Most of the investments done in stock are less diversified compared to indices investment. In ETF entire performance of indices affect your investment but in stock, a particular company can affect your investment. In stocks, you can make a huge profit margin by investing in a single successful company but indices is a slow-moving steady pace market, so will be your investment.  

Index fund vs ETF fund:

• You don't need a demat account to trade in an index fund. You have to buy from the fund house.

• You can do fraction trading in an index fund but in ETF you have to do the whole trading.

• You can buy or sell In ETF during the trading hours but in an Index fund, you have to buy units after the trading hours are done at the end of the day.  

What is a gold ETF? 

It is a commodity trading in which you can only buy and sell gold. It can be bought and sold only on stock exchanges thus investors don't have to worry about keeping physical gold.

Where can I buy the ETF?

You can buy ETF through your broker by placing order either online platform or through telephonic mode. It is similar to buying stocks online. You have to open a demat account with a stock exchange registered broker. 

  #All this data is based on mutual funds past performance please be careful before you invest your hard earned money.

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