Advantages of Exchange-Traded Funds (ETFs)

An Exchange-Traded Fund (ETF) is a type of investment option which you can buy and sell from the stock exchanges like individual shares. ETFs allow you to diversify your portfolios by pooling funds to invest in a broad range of financial assets, including stocks, bonds, commodities, and currencies. 

When you purchase shares of an ETF, you get exposure to the fund’s returns and are entitled to a share of its profits, as well as any remaining value if the fund is dissolved. This blog will give you a detailed idea of the advantages of ETF investing.

Understanding the Basics of Exchange-Traded Funds (ETFs)?

An Exchange-Traded Fund (ETF) is a type of marketable financial instrument that functions similarly to a mutual fund but you can trade it on stock exchanges.

Like mutual funds, ETFs have a diversified portfolio of assets. Based on the asset class within the portfolio, you can categorise ETFs as equity-focused, debt-focused, or hybrid funds.

Generally, ETFs work as a mirror to the performance of specific market benchmarks or indices, such as the Nifty, Sensex, or various sectoral, thematic, or market capitalization-based indices. 

Additionally, some ETFs invest in portfolios comprising bonds, commodities, or other financial instruments, depending on the index or asset class they aim to replicate.

How do the ETFs Operate?

The fund house owns the underlying assets within an ETF, which creates the fund to track the performance of these assets and then offers shares of the fund to investors. 

While you hold ownership in the ETF itself, you do not have direct ownership of the fund’s underlying assets. 

For ETFs that track a stock index, investors may receive dividends as lump-sum payments or through reinvestment, based on the dividends paid by the companies included in the index. 

Here is how ETFs function:

1. The ETF provider selects a range of assets such as stocks, bonds, commodities, or currencies, creates a diversified portfolio and assigns a unique ticker to the fund.
2. You can purchase shares of this portfolio just as they would buy shares of a company’s stock.
3. Similar to stocks, investors can buy and sell ETFs on exchanges throughout the trading day in real time.

Benefits of Investing in Exchange Traded Funds

Here are the benefits of investing in ETFs you should know before you start investing:

• Diversification

One of the key benefits of exchange-traded funds is their ability to offer diversification across a wide range of asset classes. ETFs track different indices, sectors, commodities, bonds, or a blend of various investment instruments. 

For instance, a global equity ETF might include shares from hundreds of companies spanning multiple countries and industries that could arise from concentrating investments in just a few stocks.

Diversification plays a vital role in reducing risk because the performance of different securities often balances out; when one sector or market declines, another may perform well, helping to stabilise overall returns over time.

• Liquidity

One of the other benefits of ETFs is that they are similar to individual stocks and you can buy and sell these securities during the market hours.

This intraday trading ability enhances their liquidity and gives you the flexibility to respond swiftly to market movements.

High liquidity is a significant advantage, as it enables investors to buy or sell ETF shares quickly at prevailing market prices. 

This is especially valuable during periods of market volatility, where the ability to swiftly adjust positions can help protect investments or capitalise on emerging opportunities.

• Cost-Effectiveness

Another advantage of ETFs is that it has lower expense ratios compared to traditional mutual funds. This cost efficiency stems from the fact that most ETFs are passively managed, aiming to mirror the performance of a particular index rather than surpass it. 

This passive approach reduces the need for intensive research, frequent trading, and active management, which in turn lowers management fees.

Moreover, ETFs have lower operational expenses. Since you can trade them on stock exchanges through a brokerage account, you just pay the brokerage fees but you do not have to pay the exit load which is payable for mutual funds.

How to Invest in ETFs?

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Our 2-in-1 and 3-in-1 Demat accounts allow you to invest in stocks, bonds, ETFs, direct mutual funds, etc.

So what are you waiting for? Open your account now!

Final Words

Exchange Traded Funds (ETFs) are a great choice for passive investors seeking to outpace inflation and achieve steady returns over the long term. 

While actively managed funds will likely remain the dominant component of most investment portfolios, the popularity and adoption of ETFs and index funds are expected to grow steadily.