Although ETFs or exchange-traded funds are relatively new, they have quickly acquired popularity. With a rising number of investors across a variety of industries, they offer several advantages over traditional mutual funds. It’s critical to grasp what ETFs are and how to utilize them in a portfolio before jumping on the bandwagon. Because of their trading flexibility, better transparency, lower costs, and tax benefits, ETFs have become a popular investment product in 2022. They also give a larger spectrum of risk exposure.
What is an ETF?
An ETF, or an exchange-traded fund, facilitates investors to acquire numerous stocks or bonds at once. Investors purchase ETF shares, and the funds are utilized to invest in a certain way. If you buy an S & P 500 ETF, for example, your money will be invested in the 500 firms that make up the index. ETF prices change throughout the trading day, and you may purchase ETF shares at any time the stock market is open.
ETFs vs. mutual funds
The way these two types of investment vehicles are bought and sold is the key difference. Mutual funds are priced daily, and you typically invest a set amount of money in them. Mutual funds can be bought through a brokerage or directly from the issuer, but the procedure will take time.
ETFs, on another hand, trade like stocks on major exchanges like the NYSE and Nasdaq. Rather than investing a set amount of money, you choose how many shares to purchase. ETFs’ prices change throughout the day since they trade like stocks, and you may buy shares of ETFs whenever the stock market is open.
ETF Types to Consider Investing In
Equity ETF
Equity ETFs track stock indexes from a specific industry and use active stock selection to imitate the performance of significant stock market benchmarks like the Nifty or Sensex.
Liquid ETF
These are exchange-traded funds (ETFs) that track overnight interest rates as a benchmark. These funds invest in short-term money markets or short-term maturity products with high liquidity and minimal risk.
Commodity ETF
These ETFs are passively managed funds that track a stable and simpler to track commodity market indexes, such as gold or silver.
Debt/Bond ETF
Debt ETFs combine the freedom of stock market investing with the advantages of debt investing. These are actively traded, and their expense ratio is lower than that of mutual funds.
ETF Fund of Funds
FoFs monitor other mutual funds by investing in exchange-traded funds (ETFs) managed by several asset management firms which can be classified as liquid, commodity, or equity-based on the prior classifications.
What to Consider When Investing in ETFs in 2022
When investing in ETFs, there are some factors one must consider, such as:
Underlying Index or Asset
The underlying item or asset determines the value of an ETF. As a consequence, the first step is to decide which market one wants to invest in. Decide whether you want to invest in a whole benchmark index or a specific subject or sector. Choose an index that is widely followed and offers a varied variety of options to ensure risk diversification.
Assets Under Management
The AUM is calculated by multiplying the outstanding shares by the market price per share, which fluctuates with changes in the underlying security as well as new and redeemed shares, and reflects a discount or premium based on the difference between the market capitalization and the underlying security’s NAV (Net Asset Value).
The ratio of Total Expenses
Consider the yearly management fee paid to the fund business to cover its costs, which is calculated as a percentage of the total investment.
Liquidity
ETFs have substantially higher liquidity than mutual funds since they are traded every day, and they are typically picked over ETFs with lower liquidity.
Tracking Error
The difference in returns between the ETF and the underlying index reflects how closely the
ETF tracks the index. Investing in ETFs with a low tracking error is recommended.
Bottom Line
ETFs have risen in popularity in such a short time because of their high liquidity, risk diversification, cheap fees, and simple trading system. As ETFs become more popular, their asset base expands, resulting in increased liquidity. It will benefit not only the investor but the entire economy.
How to Invest in ETFs for Beginners
Step 1: One is to open a brokerage account.
Before you can invest in ETFs, you’ll need a brokerage account. Compare the features and platform offers of each broker.
Step 2: Select your initial ETFs.
Passive index funds are often the best option for beginners since they are less expensive than actively managed funds.
Step 3: Delegate the heavy lifting to your ETFs.
Once you’ve purchased ETFs, the best advice is to leave them alone and let them do what they’re designed to do: generate exceptionally long-term investment gains.
