Exchange-Traded Funds and their Advantages: Explained

If you're looking to club mutual funds and stocks, you can consider exchange-traded funds or ETFs. ETFs are a type of fund traded on stock exchanges like stocks, but they hold multiple asset classes such as bonds, stocks, currencies, and even commodities. By the end of this blog, you'll learn what is an ETF and the rewards you can reap as an investor.

What Is an ETF?

An ETF is a basket of asset classes, such as stocks and bonds, that lets you invest in several securities, similar to a mutual fund. It lets you take advantage of stock market returns as the trade for most ETFs occurs at stock exchanges. An ETF is like a mutual fund traded on exchanges like a stock.

Fund providers combine the various assets to make an ETF and track its performance on the exchange. The firm can then sell those to the shareholders like stock. It allows shareholders to own part of an ETF but not the fund's assets.

ETF investors receive payments in the form of dividends or additional shares from the companies that make up the group.

Pros of ETFs

ETFs provide investors with a wide range of benefits. A few notable ones include the following.

• An ETF gives you exposure to various asset classes or market segments. An ETF can very well track a combination of different exchanges or even mimic returns of other indices from a specific group of countries.
• Investors can take advantage of trading liquidity like equities. For example, you can purchase it on margin and sell it short.
• Most ETFs are passively managed funds with lower expense ratios than other actively managed funds.
• You can reinvest the dividends from the fund companies immediately. However, for mutual funds, the reinvestment timing can vary extensively.
• ETFs are more tax efficient than mutual funds. You can get massive tax breaks from your own or your partner’s investments in ETFs. They’re also a viable asset to open a credit line, like a loan or a demat account.

Cons of ETFs

Some reasons why you should be wary of investing in ETFs are as follows:

• If you plan to hold ETFs for a long time, like 10–15 years, you might miss out on intraday pricing changes.
• While ETFs are cost efficient than mutual funds, that's not the case when you compare these with stocks. ETFs can get more expensive than stocks.
• Not all ETFs pay dividends, and when they do, you might not receive as much value if you have invested in stocks.

Conclusion

ETFs are a remarkably versatile option, allowing you to benefit from a basket of securities, all tracking different indices, sectors, or strategies. With benefits like diversification, liquidity, and tax efficiency, they are better than mutual funds. However, be wary of tracking errors, market risks, or hidden fees and commissions regarding ETFs, and don't invest blindly.

Fi Money allows investing in direct funds daily, weekly, or monthly via SIPs. Plus, your account has 100% flexibility and zero penalties even if you miss your scheduled payments.

Frequently Asked Questions

1. How Do ETFs Work?

Unlike mutual funds, ETFs are traded on stock exchanges like a stock. And just like stocks, the price changes daily and fluctuates per the exchange's demands. The net asset value of the underlying stock that the ETF represents decides the value of the ETF.

2. What Is an ETF Account?

An ETF account is a brokerage account that allows you to buy or sell the ETF. It can have different features and costs depending on your fund manager.