Why should ETF be your investment of choice?

A lot of people fear to invest in mutual funds because they believe that mutual funds are a high-risk investment. But what they don’t realize is that no investment is considered to be risk-free and there is always some risk associated with every investment product. Hence, before putting your money in any scheme, it is better that as a responsible investor, you first identify your financial goal. Having a defined financial goal is the key to effective financial planning. Once you have a realistic goal set, it allows you to understand how much money you need to save regularly. The next step that follows is understanding your risk tolerance. A risk tolerance/appetite is nothing but an individual’s ability to bear losses in case the investment is affected by market volatility.

If you are considering mutual funds as an investment option, it is better that you keep a long term investment horizon. That’s because mutual fund investments that are held over a period of at least five to seven years may benefit from the power of compounding and also stand a chance of beating market inflation. Mutual funds are owned by asset management companies who collect money from investors sharing a common investment objective. This pool of funds is invested across the Indian as well as in foreign economy. Mutual funds are considered to have a diversified portfolio as they tend to reduce risk by allotting their assets in various marketable security such as equity, debt, government security, corporate bonds, call money etc.

Mutual funds are subcategorized based on a certain characteristic such as investment strategy /objective, risk profile, asset allocation etc. Exchange traded funds or ETF are those open-ended mutual funds that aim to generate capital gains by mimicking its underlying index with minimal tracking error.

To find out more about exchange traded funds, read further:

What are ETFs?

Over a period of time, ETFs have gained wide acclamation among other financial instruments. ETFs have become widely popular among seasoned as well as new age investors. Securities and Exchange Board of India (SEBI), the regulator of mutual funds in India defines ETF as, “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).” Exchange traded funds follow their benchmark, which could be anything like SENSEX, NIFTY, gold, real estate, etc.

Why must you consider investing in ETFs?

ETFs are known for their unique investment strategy, which makes them a preferred investment choice among several investors. Here is why you may consider investing in ETFs:

Passive management: While most mutual funds are actively managed where the fund manager buys/sells securities to outperform its benchmark, ETFs do not involve the active participation of the fund manager. ETF’s are designed to track its underlying index with minimal tracks which makes them passive funds. Passive fund management means there is no chance for human error and also allows investors to own these at a less expensive cost.

Diversification of risk: One ETF unit comprises of several stocks and other marketable securities in smaller percentages. Investing in such a diversified portfolio might be a better choice because if one stock or sector collapses, other investments balance out the risk. Hence ETFs can be added to one’s mutual fund portfolio to for diversification as well as risk management.

Liquidity: Unlike some equity funds like ELSS which come with a predetermined lock-in period, ETFs do not have any lock-in. This means you can buy/sell your ETFs on any business day. Investors are not obligated to hold on to their ETF investments, and hence one can immediately redeem them during an emergency.

We hope that the above mentioned points prove successful in helping you get a fair idea about what exchange traded funds are. But remember that these funds are prone to market volatility and hence fund houses aren’t obliged to offer ETF holders with guaranteed returns. If you are a risk-averse investor with zero appetite for risk, it is better that you reconsider investing in ETFs. But if you want to stand a chance of seeking long term capital gains and do not mind taking the added risk, exchange traded funds might be your choice of investment.

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