Introduction to Exchange-Traded Funds

If you have been looking for good investment options to give you reasonable returns, ETFs (Exchange Traded Funds) can be an investment option you can look for. While you might read about the growth and performance of ETFs when you glance at the financial newspapers daily. But have you ever wondered what they are? In this article we will cover their definition, it’s different types and what you should keep in mind while investing. 

What are ETFs?

ETF stands for Exchange Traded Funds. As the name suggests, these funds trade on a stock

exchange. You can buy and sell these units throughout the day, just like how you deal with shares. In short, ETFs are a combination of mutual funds and direct stocks. It is an investment in units traded on an exchange, just like shares and stocks.

When you invest in these ETFs, your money is distributed throughout the stocks that are part of a particular index on a stock exchange. Some examples of these indices are BSE's (Bombay Stock Exchange) Sensex, NE's (National Stock Exchange) Nifty, etc. The values of the stocks listed on stock exchanges keep changing throughout the day due to factors. Since ETFs invest in units that are part of a stock exchange's index, their values keep changing throughout the day. ETFs can be of various types, such as Equity, gold, Debt, bank, etc.

What are the essential features of ETFs?

• The value of ETFs keeps changing throughout the day, as the price of the funds depends on the rise and fall of the underlying stock market index. 
• You can buy and sell the ETFs daily on the stock exchange, just as you trade with shares. 
• The value at which the ETF is traded on the exchange is directly dependent on the net asset value of the underlying index the fund represents. All trading activities (buying and selling) happen on the ETF's real-time NAV at the trade's time. 
• You can enjoy flexibility while investing in ETFs. You can get total exposure to all stocks in a particular niche index of your choice. ETFs are known for their affordable costs, lower risks, and transparent trading processes. 

Tips to remember while investing in ETFs

• Investors need to invest in the correct type of ETFs and aim to get optimal returns by carefully evaluating their goals, risk appetite, and time horizon. 
• Though ETFs have a lesser total expense ratio than mutual funds, they are associated with certain risks. ETFs hold stocks that are part of an index in a stock exchange. So, they are governed by the fluctuations in the stock market. 

What are the types of ETFs available for investment in India?

ETFs are pretty popular today because they are innovative investment options that give people the flexibility and diversity to invest in a basket of securities that are part of an index or indices of a stock exchange. These ETFs mimic the underlying index, and investors can buy/sell them like shares. The trading value at which these ETFs are bought and sold depends on the market performance of the fund's underlying index.

Investors should understand that there are different types of ETFs available for investing in

India. The goals, funds supported and potential returns of these ETFs will vary based on their

type. So, in the following sections, we will see the different types of ETFs available at your disposal. 

The three most common types of ETFs available for investment in India are:

• Equity ETF
• Liquid ETF
• Commodity ETF

Equity ETF

Equity Exchange Traded Funds are passive investment instruments that combine the flexibility of investing in stocks and the simplicity of equity mutual funds. These funds trade on an exchange like any other company stock and can be bought and sold continuously at market prices on a real-time basis. 

Liquid ETF

Liquid Exchange Traded Funds (ETFs) invest in short-term maturity instruments such as Tri-Party Repos (TREPS*) and other money market instruments. TREPS are highly liquid and fully collateralized. These ETFs aim to provide returns that closely correspond to the underlying market index returns, subject to tracking errors. Investors who want to park their idle cash hassle-free between trades can invest in this type of ETF.

Commodity ETF

A commodity ETF is a commodity-based exchange-traded fund that invests in assets such as gold, silver, etc. They have passively managed funds that track the underlying market index. These funds' net asset value (NAV) changes throughout the day. The fluctuation in price change depends on the supply and the demand in the markets. Here, the investor invests in stocks instead of the actual metal. Gold ETFs, and commodity ETFs, combine the features of stock trade and commodity investment. 

Trading these ETFs takes place through a Demat account and a broker, making it a highly convenient way of electronically investing in gold/silver, etc. These are ideal for investors who wish to invest in gold/silver but do not want to invest in physical form due to the storage hassles/doubt about purity and are also looking to get tax benefits.

Are ETFs the right fit for me?

Do you think long-term? Stick to your commitments, even in the face of other distractions

and temptations? Expect all dealings to be fair and just? Do you believe in patience and the rewards of perseverance? If that was a resounding 'Yes', then you seem the ideal candidate for ETFs.

ETFs follow market indices and publish their holdings daily, offering investors complete transparency in their dealings. Investors looking for value for their money tend to favor ETFs as they are passively managed and hence have lower costs. 

Finally, an ETF may be the most innovative way to reach your financial goals if you have a long-term horizon coupled with a buy-and-hold philosophy.

Learn more about this innovative investing option in the upcoming session, Easy and Secure ways to Invest: Introduction to Exchange Traded Funds.