An important aspect of making investment decisions is portfolio diversification. This is possible by parking money in various instruments including shares, mutual funds (equity, hybrid, and debt), gold, fixed income instruments, etc. Very few investors are aware of exchange-traded funds (ETFs) that can be equally invested into for exposure to some particular securities or index. As the name suggests, ETFs are like mutual funds that are traded on the exchange just like stocks. The value of an ETF is dependent on market-dependent rates, and hence can be bought and sold at any time during market hours via Demat accounts.
Why choose ETFs over mutual funds?
Many investors often ask why ETFs are preferred over mutual funds, though both do not differ much in constitution and functioning. However, buying for ETFs has some serious benefits as opposed to mutual funds that you must consider.
- Lower costs: When you buy a mutual fund, you shell out a minor percentage of your investments like mutual fund costs. These are essentially the amount charged by mutual fund managers. However, investing in ETFs does not involve payment of any advisory or management fees otherwise payable while parking money in mutual funds. The expense charged by ETFs can be as low as 5-10 basis points with one basis point being equivalent to one-hundredth of a percentage point.
- Lower holding costs: Many investors have realized a newfound interest in commodity ETFs that are most popularly traded. The holding costs are much lower than the expenses borne on the physical transfer of the commodity.
- Minimum investment: Unlike mutual funds wherein you have to deposit a minimum amount as a lump sum or through systematic investment plans (SIPs), all you have to do is spend on just a minimum of one unit of ETF while investing.
- The similarity of returns: The working of ETFs is not as per the investment decisions of any fund manager. Rather, ETFs perform to provide asset class-specific returns and mimic index movement as closely as possible.
- The benefit of real-time investment: As opposed to most other investment options wherein you decide on the basis of at the end of the day price, investments in ETFs are possible through Demat accounts during the market hours at nearly the real-time prices.
- Lock-in period: Some mutual funds may mandate a lock-in period, which implies that investors cannot redeem their holdings within that stipulated period. However, they are allowed to withdraw their money by paying a small penalty also called exit load. However, there is no time limit on the selling of ETFs, which means that you can exit your investments at ease.
- Expense ratio: The expense ratios charged by some mutual fund houses is a cause of concern. Some asset management companies charge the total expense ratio up to two per cent in the case of active funds. The charges on ETFs are much lower compared to the tune of 0.05-1 per cent of the ETF’s net asset value.
Investing money in ETFs is easy, which means that you have to just choose the ETF you want to park your money in and then decide your investments accordingly. Considering that investments in the market fetch returns that beat inflation, putting money in them can go a long way in helping you create the desired corpus.