| An ETF is a basket of securities that is traded on the stock exchange, just like a stock. So, ETFs are listed on a recognised stock exchange. Their units can be bought and sold directly on the exchange, through a stockbroker during the trading hours. ETFs can be either close-ended or open-ended. Open-ended ETFs can issue fresh units to investors even post the new fund offer stage.ETFs can be either actively or passively managed. In an actively-managed ETF, the objective is to outperform the benchmark index. On the contrary, a passively-managed ETF attempts to replicate the performance of a designated benchmark index. Hence it invests in the same stocks, which comprise its benchmark index and in the same weightage. For example, Nifty BeES is a passively managed ETF with the S&P CNX Nifty being its designated benchmark index. When you buy or sell a stock, you are basing your transaction on the predicted performance of one company. When you buy or sell an ETF, you are basing your transaction on the predicted performance of multiple companies.When you buy or sell an index, you are actually buying shares in individual companies. With an ETF, you are buying shares in a portfolio of those companies. So, if you had an opinion about a certain company in the index basket, you could make an adjustment by selling or buying shares of an individual equity (although, this is not common). With an ETF, you cannot adjust the individual equities in the portfolio. ETF units are continuously created and redeemed based on investor demand. Investors may use ETFs for investment, trading or arbitrage. The price of the ETF tracks the value of the underlying index. This provides an opportunity to investors to compare the value of underlying index against the price of the ETF units prevailing on the stock exchange. If the value of the underlying index is higher than the price of the ETF, the investors may redeem the units to the asset management company that sponsors the ETF in exchange for the higher priced securities. Conversely, if the price of the underlying securities is lower than the ETF, the investors may create ETF units by depositing the lower-priced securities. This arbitrage mechanism eliminates the problem associated with closed-end mutual funds viz. the premium or discount to the NAV. ETFs are not MFs You may get confused between ETFs and conventional mutual funds. However, they are different on several counts. The only similarity between ETFs and conventional mutual funds is that they both provide you an opportunity to invest in a variety of stocks/instruments through a single instrument. When you invest in a mutual fund, you need to buy and sell units from the fund house. Since buying and selling of ETFs is done on the stock exchange, the transaction has to be routed through a broker. If ever you can buy or redeem units in an ETF through the fund house, it is normally done in a pre-defined lot size. Typically, the lot size tends to be substantial making it feasible only for institutional investors and high networth individuals. Since ETFs are traded on the stock exchange, they can be bought and sold at any time during market hours like a stock. This is known as ‘real time pricing’. In contrast, mutual funds can be bought and redeemed only at the relevant NAV; the NAV is declared only once at the end of the day. As a result, you have the opportunity to make the most of intra-day volatility in case of ETFs. This may not hold much significance if you are a long-term investor. Mutual funds are always available at end-of-day NAV, whereas ETFs do not necessarily trade at the NAV of their underlying portfolio. In fact, the market price of an ETF is determined by the demand and supply of its units, which in turn is driven by the value of its underlying portfolio. But in case of a close-ended ETF the price remains fixed. Therefore, the possibility of an ETF trading below (at a discount) or above (at a premium) its NAV does exist. |
FAQs
"You can get broad-based diversification with one ETF, commonly referred to as diversified ETFs, or you can build a portfolio of five to 10 ETFs that would offer good diversification," he says. The choice you make on the above depends on your investment goals and risk appetite, like any investment.
What is the basic understanding of ETF? ›
ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.
How do ETFs work for dummies? ›
A cross between an index fund and a stock, they're transparent, easy to trade, and tax-efficient. They're also enticing because they consist of a bundle of assets (such as an index, sector, or commodity), so diversifying your portfolio is easy. You might have even seen them offered in your 401(k) or 529 college plan.
How do you understand the performance of an ETF? ›
Since the job of most ETFs is to track an index, we can assess an ETF's efficiency by weighing the fee rate the fund charges against how well it “tracks”—or replicates the performance of—its index. ETFs that charge low fees and track their indexes tightly are highly efficient and do their job well.
Is 7 ETFs too many? ›
Generally speaking, fewer than 10 ETFs are likely enough to diversify your portfolio, but this will vary depending on your financial goals, ranging from retirement savings to income generation.
Is 12 ETFs too many? ›
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification. But the number of ETFs is not what you should be looking at.
What are the disadvantages of ETFs? ›
Disadvantages of ETFs. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ETFs are traded on the stock exchange like an individual stock, which means that investors may have to pay a real or virtual broker in order to facilitate the trade.
Why ETFs are good for beginners? ›
They can be especially valuable to beginning investors. That's because they won't require the time, effort, and experience needed to research individual stocks. The cost to own an ETF may be lower than the cost to buy a diversified selection of individual stocks, too.
How do I choose an ETF for beginners? ›
Before purchasing an ETF there are five factors to take into account 1) performance of the ETF 2) the underlying index of the ETF 3) the ETF's structure 4) when and how to trade the ETF and 5) the total cost of the ETF.
What is an ETF in layman's terms? ›
An ETF, or Exchange Traded Fund is a simple and easy way to get access to investment markets. It is a pre-defined basket of bonds, stocks or commodities that we wrap into a fund and then we list onto the exchange so that everyone can use it.
Traders and investors can make money from an ETF by selling it at a higher price than what they bought it for. Investors could also receive dividends if they own an ETF that tracks dividend stocks. ETF providers make money mainly from the expense ratio of the funds they manage, as well as through transaction costs.
How to tell if an ETF is good? ›
The three things you want to look for are:
- The fund's liquidity.
- Its bid/ask spread.
- Its tendency to trade in line with its true net asset value.
The top tips for reading an ETF fact sheet include:
- Identify the ETF's ticker symbol.
- Examine the ETF's investment objective.
- Analyze the ETF's performance history.
- Check the ETF's expense ratio.
- Evaluate the ETF's holdings.
- Analyze the ETF's risk metrics.
The two ways to see how closely an ETF matches the index performance are 'tracking error' and 'tracking difference'. Tracking difference addresses how closely the ETF tracks the index returns, while tracking error reflects how consistent over time the tracking quality is.
What is the best ETF analysis tool? ›
Morningstar excels in its ability to provide a holistic analysis of ETFs. Investors can access detailed information on a fund's historical performance, risk metrics, and expense ratios.
How many S&P 500 ETFs should I buy? ›
SPY, VOO and IVV are among the most popular S&P 500 ETFs. These three S&P 500 ETFs are quite similar, but may sometimes diverge in terms of costs or daily returns. Investors generally only need one S&P 500 ETF.
How much of your money should be in ETFs? ›
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all. Consider the two funds below.
What is the 70 30 ETF strategy? ›
This investment strategy seeks total return through exposure to a diversified portfolio of primarily equity, and to a lesser extent, fixed income asset classes with a target allocation of 70% equities and 30% fixed income. Target allocations can vary +/-5%.
How many Vanguard ETFs should I own? ›
Build a fully diversified portfolio with just 4 ETFs
This level of diversification can help reduce your overall investment risk while making it easier to manage your portfolio.
