Exchange Traded Funds: How to select a suitable ETF fund

If you are new to the world of investing, you might have heard someone talking about mutual funds as a decent investment option. For those who do not know, mutual funds are a pool of professionally managed funds that collect money from investors sharing a common investment objective and invest the funds in securities across the Indian economy and asset classes. It is the duty of the fund manager to buy/sell securities in accordance with the scheme’s investment objective.

The problem with a lot of young investors is that they have the tendency of having high expenses and save very little of their monthly income. But if you want to become financially stable in future, you might want to start investing now so that you don’t have to worry later.

But if you are considering mutual funds as an investment option bear in mind that mutual fund investments are exposed to market volatility and fund houses aren’t obligated to offer investors with guaranteed returns. So it is better that before making any investment, you first succeed in understanding the primary reason behind your investment. Having a defined financial goal is necessary for efficient financial planning. If you want to save a decent capital for future, you need to start saving now.

In the recent past, exchange traded funds have picked up the interest of both new age as well as seasoned investors. A lot of individuals are considering ETFs for long term investments and also to give their investment portfolio some diversification. If you wish to find out more about exchange traded funds, read further.

What are Exchange Traded Funds?

According to SEBI (Securities and Exchange Board of India), the regulator of mutual funds in India, an Exchange Traded Fund is – “an open ended scheme which replicates/tracks the particular index. Of the total assets, this fund must invest a minimum of 95 per cent in securities of a particular index (which is being replicated or tracked)”.

To simplify, an exchange traded fund (ETF) is somewhat similar to an index mutual fund. An ETF tracks the vagaries of its underlying index, for example, SENSEX, gold, NIFTY50 etc. with minimal track error. ETFs are passively managed. How? That’s because exchange traded funds track the performance an index and do not involve active participation of the fund manager.

How to select a suitable exchange traded fund?

There are several asset management companies (AMCs) and fund houses offering exchange traded funds to investors. But choosing the right fund can become a tad confusing at times. Here are a few things to bear in mind while picking a suitable ETF fund.

Track performance

How has the exchange traded fund performed in the past? How is it performing as compared to its peers? What is the underlying index which the ETF is tracking? Has the ETF beaten its benchmark in the past? These are some of the things one should evaluate while choosing an exchange traded fund. Understanding the past performance of the fund is essential as it gives you an idea of whether the fund holds any potential for investment. However, do understand that the past performance of a fund may or may not replicate its current or future performance.

Fund management

It is vital that you invest in an exchange traded fund that belongs to a well reputed AMC. That’s because an ETF belonging to a reputed AMC is expected to have a reputable management staff as well. A credible and reputed management usually plays a vital role in the long and successful run of any mutual fund. Hence it is better that you do some research and find out about the management and the AMC before investing your hard earned money.

Expense ratio

An expense ratio of a fund is the recurring costs which a fund has to bear for its functioning. These costs include fund manager fees, trustee fees and other management costs. ETF holders have to pay annual fees in the form of expense ratio for owning the fund. Considering ETF is a passively managed fund, the expense ratio of owning this fund is low. But every ETF’s expense ratio will vary and hence it is better that you consider this factor while choosing an ETF.

Exit load

Exit load refers to the fee levied by the AMC or the fund house on the ETF holder while withdrawing or redeeming their ETF units. If an exchange traded fund has a higher exit load, it might affect the withdrawer, especially if he/she is selling the ETF units soon after investing. However, if you remain invested for the long run, you may or may not have to worry about the exit load.

We hope that the aforementioned points assist you in choosing an optimum ETF. The key to successful investing is having a long term investment horizon. Remain committed to your investments and continue investing until your investment objective is met.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully