One of the best ways to follow a passive investment strategy is by adding exchange traded funds to your portfolio. Also referred to as ETFs, these funds predominantly invest in their underlying benchmark and try to generate returns close to that of its benchmark with minimal tracking error. These are similar to index mutual funds, only better because of their ability to be traded at their live market price at the stock exchange just like company stocks. To make the most out an exchange traded fund, one must know how to use them in a smart way.
If you are a first time investor or someone who has been investing in mutual funds for quite some time, investing in ETFs will only add more value to your investment portfolio. Seasoned investors usually consider exchange traded funds because they are more cost effective and carry a low expense ratio. First time investors can consider ETFs as their portfolio is void of human biases and they get to have a hands on experience of how the stock market works.
How do ETFs add value?
Cost effective investment – Your current portfolio may consist of equity funds or international mutual funds which generally have a very high expense ratio. The expense ratio is nothing but the recurring operational costs and management costs that the AMC must bear to ensure the smooth functioning of the scheme. These costs are recovered in the form of expense ratio with investors have to bear. Since ETFs are passively managed, there is no active participation of the fund manager who has very little say in how the ETF portfolio will perform. Since ETFs are designed to generate returns passively, they have a low expense ratio.
Highly liquid and flexible – If you had to trade the units of your normal mutual fund portfolio, you will have to place an order request to the mutual fund house after which you can either buy or sell your units based on the fund’s NAV which is determined at the end of the day. However, when it comes to ETFs one does not need to wait for the NAV to be disclosed as the units are available for sale and purchase at their market price that fluctuates throughout the live trading hours. Investors can be involved in intraday trading with ETFs which is not possible with any other type of mutual fund investment scheme.
Invest low – Although not all AMCs may offer SIP options for ETF investments, one does not need thousands of rupees to start investing in ETFs. One can start their investment journey by purchasing a single ETF unit that usually costs a few hundred rupees.
Fewer tax implications – Just like other mutual funds, exchange traded funds have dividend distribution tax and capital gains tax as well. However, since most exchange traded funds are traded throughout the day between investors, there might be fewer instances of tax implications on ETF transactions.