What Is ETF?
An Exchange-Traded Fund (ETF) is an investment fund traded on the stock exchange like stocks. ETFs carry a diversified basket of assets like stocks, bonds, commodities, or a combination of these, and thus, investors can invest in different markets through a single buy. ETFs provide liquidity diversification and are less expensive than mutual funds, therefore, ETFs have become a widely used investment vehicle among institutions and individuals.
How Do ETFs Work?
ETFs are constructed to match the performance of a related index, sector, commodity, or asset class. They are made by financial institutions that buy the underlying assets and bundle them into a fund. ETF shares are issued and traded on an exchange during the day at market prices. Unlike mutual funds, which have one price per day, ETFs can be sold and purchased in real-time, like stocks.
Types Of ETFs
- Equity ETFs: These ETFs replicate stock market indexes such as Nifty 50 and provide exposure to a diversified group of companies.
- Bond ETFs: They are invested in corporate or government bonds, which give exposure to fixed income at a lower risk than equity.
- Commodity ETFs: These ETFs follow the prices of commodities like gold, silver, oil, or agricultural crops, enabling investors to invest in commodities without owning them physically.
- Sector & Industry ETFs: Sector & Industry ETFs concentrate on individual sectors such as technology, healthcare, energy, or financial services and enable investors to focus on fast-growing sectors.
- International & Global ETFs: These offer exposure to global markets and allow investors to diversify between countries and economies.
- Thematic ETFs: These ETFs track investment themes like artificial intelligence, clean energy, blockchain, or ESG (Environmental, Social, and Governance) investing.
Advantages Of ETFs
- Diversification: ETFs give investors exposure to a broad asset class in a single investment, lowering portfolio risk.
- Liquidity: ETFs are traded like stocks, enabling investors to sell and purchase shares during the trading day.
- Reduced Costs: ETFs tend to have lower cost ratios than mutual funds, reducing investment costs.
- Transparency: Most ETFs disclose their holdings on a daily basis, giving investors clear visibility into their holdings.
- Tax Efficiency: ETFs are structured so that capital gains tax expenses remain low compared to mutual funds.
- Flexibility: Shareholders can use ETFs for diversification, hedging, or short-term trading tactics.
Key Takeaways
An Exchange-Traded Fund or ETF is a security that follows an index, sector, commodity, or class of assets, and trades on an exchange such as a stock. ETFs diversify across multiple assets to reduce risk against single stocks. They can be bought and sold in real-time at market value, providing flexibility and liquidity. The most common include equity ETFs, bond ETFs, commodity ETFs, sector ETFs, international ETFs, thematic ETFs, and leveraged/inverse ETFs. They are economical, with lower expense ratios and tax benefits over mutual funds. They also offer transparency, as most report their holdings on a daily basis, and hence are a favourite investment option for long-term and short-term plans.
