All you need to know about ETFs

Mutual funds are a great investment option for individuals who do not have time to track the markets. It is an investment option made for your convenience. It is expertly managed by the fund manager and is affordable. It is safe to say that mutual funds are beginner friendly.

But if you are well-versed in the markets and wish to invest at every support level of Nifty50 or Sensex, there are better ways to go than mutual funds.

Why?

That’s because, when you buy a mutual fund, the units are allotted to you at the end NAV of the day. So, you cannot take advantage of the market’s fluctuations in the case of mutual index funds. However, Exchange Traded Funds or ETFs are such investment avenues that can help you invest in an index and allow you to take advantage of market fluctuations.

What are Exchange Traded Funds?

Exchange Traded Funds or ETFs are a basket of stocks which mirrors a benchmark Index. So, if you wish to invest in the 50 stocks of Nifty, then you could simply buy an ETF, and the returns generated by ETF and Nifty 50 would be the same. Moreover, ETFs are tradeable; hence, you can buy them anytime during market hours, and they will be allotted to you at the current price. All ETFs are passively managed. So, the aim of ETFs is not to beat the benchmark index but to replicate their performance.

Types of ETFs

There are various ETFs such as Gold, Currency, Index, Bank, Liquid and international.

Index ETFs: This is the most commonly known type of ETF. Investment in Index ETFs should generate the exact returns of the benchmark index like Nifty50 and Sensex, nothing more or less than the benchmark.

Gold ETFs: Instead of buying digital gold, you can opt for Gold ETFs. It tracks the price of 24-carat pure physical domestic gold and replicates it. It is beneficial as it is tradeable, and you can invest a small amount.

Bank ETFs: These track a bucket of banking stocks listed in the stock market. It may have Bank Nifty as its benchmark and offer returns according to the performance of Bank Nifty.

Liquid ETFs: It invests in a basket of government securities or money market instruments for the short term. The prices are not very volatile, but it offers stable returns.

International ETFs: These track global market indices like Nasdaq, Hang Seng, Nikkei, etc. These ETFs are excellent investment options for someone looking to diversify their investment portfolio into foreign markets.

Advantages

Tradable: The most significant advantage of ETFs is that they are tradable. You can use your knowledge, decide the correct entry and exit level and make money without worrying.

Cost efficient: ETFs and mutual funds belong to almost the same family regarding taxes. Both investment options are subject to capital gain tax. But, the expense ratio of ETFs can be as low as 0.25%, compared to mutual funds, which are usually 1.5% - 2.25%.

Zero exit load: No matter when you sell an ETF, there is no exit load like mutual funds. Hence, if you are a trader then ETFs can be more profitable for you than a mutual fund.

Taxation

ETFs are taxed in two ways - equity-oriented and non-equity-oriented ETFs.

Equity-oriented ETF: If you invest in an index ETF or equity ETF and hold it for less than a year, then short-term capital gain tax will be levied at 15% + 4% cess. If you hold it for more than a year, then long-term capital gain tax will be levied at 10% without indexation above Rs 1 lakh.

Non-equity-oriented ETF: If you invest in gold ETF, liquid ETF or international ETF, then it is treated as a non-equity ETF.

If you hold the investment for less than 36 months, the tax will be levied as per your tax slab. If you hold for more than 36 months, then a tax of 20% after the indexation benefit will be levied.

Conclusion

While investing in an ETF, always buy a fund with low tracking error.

Tracking error is a difference between the benchmark’s return and your ETF return. So, if Sensex has offered a return of 2.53% in a week, then your ETF, which has Sensex as a benchmark, must also offer 2.53% returns.

Indeed ETF is a great investment option for traders and long-term investors as it is cost-effective. But remember, you must open a Demat account before investing in an ETF.

(The writer is the Head of Research at Teji Mandi)