An Exchange Traded Fund (ETF) is a passive investment fund that tracks and replicates a market index. As these are pooled investment vehicles, their underlying portfolio can comprise money market instruments, bonds, shares, commodities, etc. An ETF is marketable security and can be traded on a stock exchange just like shares. ETFs offer a host of benefits to investors, such as liquidity, transparency, and tax benefits. Here are some reasons why you should invest in ETFs.
Advantages of investing in ETFs
Investing in ETFs helps diversify your portfolio as it supports a group of assets against an investment in the shares of a single company. By design, it is built to follow a broad range of stocks or an index, thus helping to spread your finances better.
Another reason why ETFs are suitable is that they can be bought and sold on the stock exchange just like ordinary shares. This feature makes ETFs highly liquid, especially in comparison to mutual funds. The net asset value of a mutual fund can be derived only at the end of a day. An investor has the immediate flexibility to sell and exit from a particular ETF if it’s not fetching desired returns and instead park the money elsewhere.
Since ETFs are passively managed and not actively managed by an asset management company (AMC), it attracts a lower expense ratio. Typical costs associated with managing a fund include fees, marketing expenses, entry and exit load, paying the board of directors, etc. When all these costs are added, the expense ratio of ETFs, in many cases, tends to be much lower as compared to mutual funds. This is one of the significant benefits of investing in ETFs.
Disadvantages of ETFs
Some ETFs targeting particular sectors or foreign stocks follow only large-cap stocks, which may happen due to a limited number of equities existing in that specific market index. Hence, ETF investors may miss out on the growth potential or opportunities in the mid-cap and small-cap categories of stocks.
While transparency in intraday pricing may be excellent for some investors, it can be precisely the opposite for long-term investors with an investment horizon of 10–15 years. In such a scenario, their long-term investment objective may go for a toss, and they may end up selling more stock due to irrational fears creeping in. While there are a few disadvantages related to ETF investments, many experts agree that the advantages for the same outweigh the negatives by a considerable margin. ETFs could be great investment vehicles for people with limited time to analyze individual companies and those who wish to diversify their portfolios.