Investing in the stock market is considered to be the best way to grow your wealth for the long-term. The main reason for the popularity of the stock market is it will offer many financial products. One of them is mutual funds. It is professionally handled and manages with the help of experts. You should know that these types of funds are of many kinds, but one of the popular mutual funds is Exchange Traded Funds (ETFs). It is a fund that is generally tracking all the behavior of the stock market index. Not like the other mutual funds, the units of ETF are traded only on the stock market, such as shares of the company.
Why should one have to invest in ETFs?
ETF is offering great scope and a wide range of investment options and broad diversification for the investors. It will provide exposure to the indexes which is based on the following,
- Market cap such as large, mid, and small caps.
- Market sectors such as agriculture, infrastructure, technology, and more.
- Asset classes such as real estate, commodities, fixed-income, and so on.
How do you invest in ETFs?
You can spend in Exchange Traded Funds (ETFs) in two ways. The first way is through telephone. You will be contacting the broker in order to place the detailed order. The second way is via online by trading terminals. It is available in the form of websites, or you can download the mobile application as well. Like any other security, you should open a trading as well as Demat account for this. Then you have to fulfill all the KYC compliances mentioned in it.
If you are going to trade the ETF in the stock market, it is essential to buy units of the funds. But you have to remember the important point that you cannot buy a fraction of the unit for ETF like other normal funds. Every fund houses will be offering an indicative NAV for helping the investors to make the decisions better. This indicative NAV is different from market price, and it totally depends on the demand and supply of the fund. Since it is traded just like the shares, these trades will have a brokerage, tax charges and commission.
Types of ETFs
In addition to the market indices, these funds can be created for tracking the performance of some other economic events as well. Here are some of the types of ETF and they are as follows,
- Commodity ETF: It involves investing in commodities or derivatives.
- Bond ETF: It allows you to invest in the bonds.
- Industry ETF: It is also known as sector ETF, and it used to track the performance of a sector or industry.
- Inverse ETF: It allows you to invest in derivatives for gaining the profit from a decline with the value of the market index.
- Currency ETF: It helps in tracking the relative value of any currency.
Why do investors choose ETFs?
When you are having an understanding of when to use the ETF, you will be succeeding in it. There are many reasons available for making an investment in ETF for gaining benefits.
- Does not need a lot of money
Every share might go beyond 100 dollars. It is generally lesser than that amount too. With this amount, your share might get you interest in hundreds from a wide range of companies. In case, if you are investing some minimum amount in one stock, then there might be a chance to lose all your money if the company does not perform well. But when the company is performing well, you will be gaining a significant rise in profit. Hence you have to ensure that your ETF has the potential to offer a steady profit in which you find comfort.
- Ease of access
Since it has wide coverage, one can able to invest in bonds, stocks, commodities, and even a mix of assets called hybrid ETF. Hence it will be offering the ease of access to a wide range of asset classes. Generally, these funds will provide you with along with the entire market using a single fund. And it will provide you high transparency level because the investment holdings are distributed on a daily basis. It also helps the investors to make ease during the ETF portfolio building.
- Provides subsectors of a certain asset class
These classifications will allow people to invest in companies that belong to some other industries. You might also benefit from investing in the company’s stock, which is performing well since the ETF digs down to provide your certain assets.
You should know that this kind of ETF is not charging high management fees. It is because of the limited duties of the fund manager. They will be kept on checking the ETF to track the index’s performance. It is considered to be one of the cost-effective when compared with the index and mutual funds. In addition to that, you can also get your tax benefits.
Why is ETF so cheap?
Many people choose ETF because of its low fees. Yes, it is really cheaper when compared with mutual funds. Even though it is reasonable and inexpensive, investing which might include certain costs. But do not worry about that. You have to consider two things one is commission, and the other is operating expenses.
About trading commission:
It is possible to trade online commission-free, and this commission cost is not as important for the consideration. Though, you need to check with the broker about the cost of commission. Generally, it might range from zero dollars to 20 dollars. It may be high if you are trading over the phone or in person. Keep the following points in your mind while paying the commission to trade ETF,
- If you are often trading, you will be paying more in total commissions.
- You should know that the cost percentage will be smaller for large trades and large for small trades.
Commissions are playing a major role in the ownership of the total cost if you are trading often using smaller amounts. It means that the traders have to pay attention to the commission costs when comparing to the long-term. And ETF is not an ideal option for those who are frequently investing a minimum amount for longer-term.
About operating expenses:
Most of the Exchange Traded Funds (ETFs) is having low operating expenses when compared with the managed mutual funds. The expenses of the ETF are usually stated in terms of the operating expense ratio of the fund. It is considered an annual rate charged over the total assets it is holding to pay the admin, portfolio management, and other costs. Since the operating expense ratio is an ongoing expense, it is generally relevant for all the investors, especially for the long-term and by buying and holding investors.
Bid /ask spreads:
The two mentioned above things are easy to understand for the investors. But they have to aware of the third cost, which is known as bid/ask spread.
- The bid is considered to be the market price at which the ETF could be sold
- The ask is the price in which the ETF can be purchase
The difference between the two prices is known to be the bid/ask spread. One can able to think that it should be the transaction cost, which is similar to the commission. So, if you are often trading with the large spread, the more it should be its cost.
How will the ETF benefit the portfolio of yours?
We all know that ETFs is one of the popular vehicles of investment. People who are taking advantage of this fund as part of their investment strategy might reap many benefits. Here are some of the benefits of investing in ETF and they are as follows,
- Single transactions
You should know that ETF is replicating the indexes holdings. Hence it follows certain regions’ industries and any other sectors in which the index can track off. So, investing in ETF generally offers the same group of holdings using a single transaction. You have to think of the share as the mini-portfolio of its own. It helps in simplifying the process of buying, and hence as an investor, you should not have to place more orders.
Even it helps in simplifying the purchasing process, and it does not sacrifice over the liquidity. Just like the stocks, this fund is also trading during the market hours. The liquidity allows the people to hump on the positions as often as they want. It can be sold on margin or short, and the prices will be updated continuously during the trading day. On the other hand, it can be traded like the stock market’s equities.
It is easy for investors to save their money using ETF. Since you can transact only once per day, you will be going to avoid the commission fees that can occur if you add the stocks into the portfolio. And the managing fees will also be lower for this fund when compared to the regular mutual funds. You can avoid the load fees as well.
- ETF taxes
If you search over the internet about the ETF, you might be heard of the terms ETF is the tax-friendly investment. Yes, it is true while comparing with the other traditional mutual funds. The capital gain in the case of ETF is not realized if the asset is not sold. It actually means that people can effectively pick when to execute the taxes of ETF on themselves. So, investors need to pay their tax over the dividends as distributed.
- Immediate dividends
Almost many of the ETF distributes the dividends as the stock would. People will be gaining the payment for a quarterly dividend, which is dropped into the brokerage account. But when you are thinking about the traditional mutual funds, the time frame will be varying, and most of them will distribute the dividends only annually and not quarterly.
- Easy to understand
The structure of the ETF is really simple and easy for understanding about it. The investors might get full knowledge about their investment products and products such as ETF, which will lower all the barriers to understanding the investment. Hence, if you seek the best way to make an investment in a particular industry, you should get started with ETF.
Apart from those mentioned above benefits, investors will gain a lot more if you are including ETF in the investment portfolio of yours. It is one of the best weapons which should be considered as part of investing resource.
Know about the applications
As an investor, you have to aware of the application of the ETF. You can use the ETF for the following purposes,
- They can be used as efficient trading. Investors can choose to make an investment in a wide range of sectors.
- It should be used for cash utilization. People can choose ETF as a short-term investment tool. It also helps them to save the opportunity costs.
- It can be used in cash flow management.
- Since it offers exposure to many sectors and industries, it can be used for filling the space.
- It will be used as a tool for safeguarding from the market risk since it can be sold and borrowed easily.
- People can use the ETF as an arbitrage for trading the cash and the futures market.
Exchange Traded Funds (ETFs) will always be bringing better and best opportunities for investors. But you have to use this wisely by paying attention to all the above-discussed things. You should know that the investment options are working for someone and might not be suitable for others. As an investor, you have to properly find your investment option based on your needs and requirements. Know that any investment might come with a specified risk. If you are the person who needs to invest a limited amount at lower risk, then ETF is a wonderful option for you.