In continuation to the earlier article What are Exchange Traded Funds? This article gives a short glimpse of things that help you understand the core of ETFs.
How ETFs are Similar to Mutual Funds?
Most ETFs are generally Index-style investments, very similar to the index mutual funds. ETF simply buys and holds the stocks as they are in the their benchmark like the Nifty50 Index or BankNifty Index which means that the ETF based on Nifty50 Index will buy the same 50 stocks in same proportion as they are in Nifty Index. Investors therefore know what securities their fund holds, and they enjoy returns matching those of the underlying index. Therefore, If the Nifty50 Index goes up 10 percent, your NiftyBees ETF will go up 10 percent, less a small fee.
How ETFs are Different from Mutual Funds?
Like mutual funds, ETFs pool investor assets and buy stocks as per their benchmark. But ETFs trade just like stocks, that is, you can buy or sell ETFs anytime during the trading day while Mutual Funds are bought or sold at the end of the day, at the price, or net asset value (NAV), determined by the closing prices of the stocks or bonds owned by the fund.
Generally, disclosure of portfolio holdings happens once in month/quarter while in case of ETFs there is daily disclosure of portfolio holdings to market participants.
ETFs can be Traded Short during the Trading Day
ETFs are traded just like stocks, so ETFs can be sold short (a way of profiting if the ETF price drops instead of rises) during the trading day. This difference makes ETFs better for day-traders betting on short-term price changes of entire market sectors. ETFs are great way to trade the market on the big event days like Budget, RBI Monetary Policy, etc. Any trader who sees the market to drop on the big budget day can sell short NiftyBees ETF and buy it back later during the day at lower prices.
Being Aggressive & Conservative at Same Time
Over the long run, diversification reduces risk without impacting returns. Any investor who wishes to get exposure to any sector or industry can hand pick some stocks from that industry to invest in or can simply buy an ETF that benchmark the sector’s index.
So, any investor by investing in an index ETF is conservative by diversifying its portfolio by investing in a number of stocks which in turn help him stay protected against the volatility and risk of investing in a few companies within the sector and also he is aggressive at the same time by investing in the big companies which are perfoming in that particular sector.
Advantages of ETFs over Mutual Funds
Lower Expense Ratio
Actively-managed mutual funds incur a management fee that can sometimes be more than 2.00% while ETFs expense ratios are typically in the 0.25% – 0.75% range.
As ETFs are traded on a securities exchange throughout the day, the opportunities for short-selling exist for the trader. ETFs are great way to trade the market also on big event days like Budget, RBI Monetary Policy, etc.
Mutual funds are only priced once at the close of the market. Conversely, ETFs are priced throughout the day and can be bought and sold on the exchange.
ETFs are purely transparent. Investors exactly know which securities are held in each ETF. This is not the case with the many managed mutual funds.
KNOWLEDGE IS POWER!