| 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
An exchange-traded fund (ETF) is a basket of securities that trades on an exchange just like a stock does. ETF share prices fluctuate all day as the ETF is bought and sold; this is different from mutual funds, which only trade once a day after the market closes.
Are ETFs good for beginners? ›
The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.
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.
What is ETF basics for beginners? ›
An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once. Investors buy shares of ETFs, and the money is used to invest according to a certain objective. For example, if you buy an S&P 500 ETF, your money will be invested in the 500 companies in that index.
What is the downside to an ETF? ›
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
What do you actually own when you buy an ETF? ›
Exchange-traded funds work like this: The fund provider owns the underlying assets, designs a fund to track their performance and then sells shares in that fund to investors. Shareholders own a portion of an ETF, but they don't own the underlying assets in the fund.
Can you cash out ETFs? ›
ETF trading generally occurs in-kind, meaning they are not redeemed for cash. Mutual fund shares can be redeemed for money at the fund's net asset value for that day. Stocks are bought and sold using cash.
Do I have to pay taxes on ETFs? ›
Dividends and interest payments from ETFs are taxed similarly to income from the underlying stocks or bonds inside them. For U.S. taxpayers, this income needs to be reported on form 1099-DIV. 2 If you earn a profit by selling an ETF, they are taxed like the underlying stocks or bonds as well.
How many ETFs should I own as a beginner? ›
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
Do ETFs pay dividends? ›
One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.
Exchange-traded funds are similar to mutual funds in that they hold a collection of stocks and bonds in a single fund. Unlike mutual funds, they are bought and sold on stock exchanges, can be traded anytime the exchange is open, and you can start your ETF investing even if all you have to invest is $50.
How much should I invest in an ETF for the first time? ›
You can put $500 in a stock ETF and $500 in a bond ETF to achieve a diversified two-asset-class portfolio which, though simple, can be a great start toward building a portfolio appropriate for your goals. ETFs can be a simple way to build incrementally toward your long-term plan.
Should I just put my money in ETF? ›
ETFs can be a great investment for long-term investors and those with shorter-term time horizons. 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.
Should I start investing in ETFs? ›
Key Takeaways. ETFs are considered to be low-risk investments because they are low-cost and hold a basket of stocks or other securities, increasing diversification. For most individual investors, ETFs represent an ideal type of asset with which to build a diversified portfolio.
