Exchange Traded Funds (ETF)- Meaning, Benefits, and Risks

If you’ve invested in mutual funds, stocks, and alternative assets and want to know more about a new investment option like an Exchange Traded Fund (ETF), you’ve come to the right place. 

ETFs are one of the most transparent and liquid investments on the market. But what are ETFs and why are several investors adding ETFs to their portfolios? Understanding the inner workings of ETFs can help answer this question. 

What Are Exchange Traded Funds (ETFs)?

An Exchange Traded Fund (ETF) is a collection of securities that you can trade on the stock exchange. ETFs tend to mirror or ‘track’ the index that they are trading under.

Similar to mutual funds, ETFs invest in various stocks, bonds, and other securities and ETFs can be bought and sold on the share market just like stocks.

How Does An ETF Work?

ETFs can be traded during the day just like stocks. You can buy or sell an ETF based on the NAV of its underlying assets like stocks, bonds, commodities, etc. Whether or not you receive dividends depends on the AMC or performance of the ETF.

An ETF is similar to an Index fund but the annual charges are lower. Moreover, an Index fund is not actively traded during the day like an ETF.

Since the trading process is similar to stocks, you’ll need a brokerage account to invest in ETFs. Investment apps like Cube allow you to invest in Indian and US ETFs with just a few clicks.

Actively Managed ETFs Vs Passively Managed ETFs

ETFs, for the most part, are not as actively managed like mutual funds. However, based on the AMC, ETFs can be actively or passively managed. Let’s look at the key differences between the two methods.

1. Actively managed

These ETFs employ the expertise of a portfolio manager or a team to invest in high growth assets in the underlying index. The fund manager will re-allocate across sectors and companies based on their judgment. 

Actively managed ETFs may produce returns that do not mirror the underlying index. 

2. Passively managed

A passively managed ETF will mirror the holdings of the underlying index to try and replicate the performance of the market or segment. 

Some investors prefer this hands-off approach because of the notion that it’s more difficult to beat the market than to mirror it. 

However, passive ETFs may carry a higher risk than actively managed ETFs due to a lack of flexibility and a heavy reliance on stocks with the highest market cap.

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Types Of ETFs In India

1. Equity ETFs

An Equity ETF combines the functionality of stocks and equity mutual funds. These ETFs invest in equity and equity-related instruments like shares.

Most Equity ETFs are passively managed instruments that mirror the underlying index. The holdings of an Equity ETF is completely transparent. Equity ETFs have lower expense ratios than mutual funds. 

2. Debt ETFs

Debt ETFs give the benefit of good debt, the flexibility of stocks and the convenience of mutual funds. Debt ETFs invest in fixed income securities. 

Most Debt ETFs are passively managed instruments that mirror the underlying index. The holdings of a Debt ETF is completely transparent. Debt ETFs have a lower expense ratio compared to mutual funds. 

3. Gold ETFs

Gold ETFs give you the best of both gold and stock investments. Gold ETFs invest in gold bullion. 

Gold ETFs are passively managed instruments that are based on gold prices. Gold ETFs incur a lower cost compared to physical gold. The holdings of a Gold ETF is completely transparent.

Benefits of Investing in ETFs

1. Lower expenses

The expense ratio that you would pay for ETFs is generally lower than mutual funds.  

2. NAV Clarity

The NAV of a mutual fund is known after the market closes. But an ETF’s NAV is observable in real-time throughout the day since it can be bought and sold like a stock. 

3. Better Liquidity 

An ETF has better liquidity than a mutual fund because you can buy or sell an ETF instantly during the trading hours.

4. Better tax benefits

ETFs are generally considered to be more tax-friendly than mutual funds due to the lower expenses. However, ETFs are subject to dividends tax and Capital gains tax. 

Risks Of Investing In ETFs

1. Volatility

ETFs carry similar risks to stocks since they are market-linked instruments that are traded day-to-day.

2. Brokerage fees

Unlike mutual funds, you’ll need to open a brokerage account and pay a brokerage fee to buy and sell ETFs. This cost can eat into your profits.

3. Diversification

Most ETFs are passively managed. This means that an ETF’s portfolio is capitalization-weighted, in that it invests in the only the biggest stocks of an index. 

There’s a possibility that this strategy might leave out high performing small-cap or mid-cap stocks that may require active management and daily judgment of a fund manager. 

Difference Between ETFs, MFs, and Stocks

Here’s a table that charts the difference between ETFs, Mutual funds, and Stocks. 

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How Cube Can Help You Invest In The Best ETFs

Cube is the best way to invest in ETFs available in India and the US. The Cube Wealth app gives you access to ETF recommendations from Purnartha, our Indian equities advisor 

Purnartha has a historical track record of delivering 37.30% CAGR. Their solid approach is centred around investing in high growth companies for the long term.

You can even diversify your ETF investments geographically by investing in US ETFs or Global ETFs using Cube with world-class advice from award-winning RIA, Rick Holbrook. 

Rick has 40+ years of experience in the international markets and currently manages ~$130 million in assets for HNIs.  

Watch this video to know how US stock advice works on Cube

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Summary

• ETFs invest a pool of money in different securities
• ETFs can be bought and sold on the share market
• You’ll need a brokerage account to invest in ETFs
• ETFs are liable for capital gains tax and dividends tax
• ETFs have lower fees than mutual funds
• You can invest in the best Indian, US, and international ETFs using Cube

Download the Cube Wealth app or speak to a wealth coach today to know more about ETFs.

Here’s how Indian Stock Advice By Purnartha Works On Cube

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