Exchange Traded Funds– For understanding the ETFs better let’s first understand Mutual Funds and Index Funds.
Basically what’s a Mutual Fund?
A large number of people are giving their money to a mutual fund company, and that company has a team of professionals which is expert in picking up the stocks and this team will now invest our money in shares and profit from investing in the shares is what we get as returns. So this is basically Mutual Funds.
Now let’s understand the Index Funds
In Index Funds we have a similar pattern where a number of people are passing their money to a mutual fund company but here the mutual fund company doesn’t have a team of experts to pick up the stocks for investing and the company straight away invests all the money in the Index like Sensex, Nifty etc.
Now What is an Index ?
- So, basically Sensex is the group of listed top 30 companies of India.
- Nifty is the group of listed top 50 companies of India
- In the mid cap category we have a group of top 50 companies, similarly the small cap category has a group of top 50 companies.
Index funds invest straight in a particular group, fund manager does not choose any particular stock and whatever stocks are lying in a particular group they are part of that particular Index and fund manager will invest only in those particular stocks. So these are known as Index Funds.
Now that we have understood both Mutual funds and Index Funds, let’s come to our topic which is ETFs.
Though ETFs can be active funds as well but most of the ETF funds globally are passive funds or the Index funds in a way. There is no active stock selection in ETFs and that’s the first characteristics of the ETFs.
Most of the ETFs are like Index funds so they cannot outperform the Index funds for sure as we don’t have any experts to find out the undervalued or overvalued stocks in the market. If the ETFs are similar to the Index funds, then what’s the difference between the two.
So, the first major difference is, as the name suggests, exchange traded funds can only be purchased from the stock exchange like BSE or NSE. So, this is more like buying shares, you can’t buy the ETFs like we buy mutual funds.
Second big difference is buying and selling the ETFs
Like in case of Mutual Funds whenever we want we can buy or sell our funds and the money gets credited into our accounts directly but in case of ETFs as this is an Exchange Traded Fund, we should always have a buyer when we want to sell our ETFs and a seller whenever we want to purchase the ETFs.
Now let’s understand the advantages of the ETFs.
- Real Time Trading
You can buy the ETFs in real time. As in case of mutual funds the NAV is fixed at a particular point and it will not vary throughout the day. So if you want to purchase mutual funds you buy it in the morning or evening it doesn’t make any difference the nav is going to be the same. But in case of ETFs the price varies every moment which is the best part for traders who want to trade in the Index with much risk. So, if you know that the Index is down by 5-7% today, and you want to take advantage of this, that’s possible in case of ETFs as opposed to that it may not be possible in case of a mutual fund.
Stocks are traded on all days of the week in a stock market exchange except sundays and saturdays and holidays declared by the Exchange.Below given table shows the trading hours of the market–
|Pre-open session||Open: 09:00 hrs
Close: 09:08 hrs
|Regular trading session||Normal / Limited Physical Market Open: 09:15 hrs
Normal / Limited Physical Market Close: 15:30 hrs
|Closing Session||15.40 hrs and 16.00 hrs|
|Block Deal Session||Morning Window: 08:45 AM to 09:00 AM.
Afternoon Window: 02:05 PM to 2:20 PM.
- Cost Effective
As we know the ETFs are passively managed funds, we have a very low expense ratio as compared to mutual funds which are actively managed funds. But when compared to the Index Funds, earlier it used to be cost effective but today we have index funds available at a very low price and they both are very competitive now.
- Tax Benefits
In case of ETFs, capital gains are not realized until the entire assets are sold, and you will not pay the taxes till the time you hold them. As ETFs are not active funds, they are traded less frequently and hence incur less taxes as compared to the mutual funds which are actively managed funds and every trade will have an opportunity for the capital gains and taxes.
As we know most of the ETFs are passively managed funds which are following a particular Index and require no adjustments to be made, which makes it a very low risk fund as compared to the mutual funds.
Disadvantages of ETFs
- Traded on Exchange
This is the major drawback of an ETF that is traded on exchange. As we know, we can buy or sell ETFs only when a buyer or seller is available in Exchange. If you don’t have any buyer even if you want to sell your ETFs you may be able to and that’s the biggest disadvantage as opposed in the mutual funds whenever we want we can buy or sell our funds.
- Not possible to Outperform
As most ETFs are passively managed it becomes almost impossible to outperform in the market as it is following a particular Index.
- Cost might be higher
Yes, ETFs are cost effective when compared to the mutual funds but if we compare them with the individual share, in that case the cost will be higher.
- Very Less Control
As ETFs will be following a particular Index, an individual will not have any control over any of the stock under that index whether he likes it or not. So if you don’t like a particular stock and don’t want it to be a part of your portfolio you will still have that stock.
- Sell at loss because of market sentiments
As the prices of ETFs are shown live going up and down with the market we might sell our ETFs just because of fear or loss.
So concluding on that note, should you go for ETFs.
Well, if you want to invest for a longer period of time then best is to go for mutual funds they will give you good returns in the long run and there is no point investing in ETFs if you want to stay invested for a long period.
And if you really want to invest in Index Funds then rather than going for ETFs you can directly go to the exchange and invest in the Index Funds.