ETF or Exchange Traded Fund is very much similar to the mutual fund but they are different from each other. They both pool capital from investors and invest somewhere in order to earn a profit on this investment. But the working and asset management are different in both funds. In this post, we will discuss the ETFs with their working.
What is ETF?
ETFs or Exchange Traded Funds are the investment funds that are listed and traded on a stock exchange, like stocks. It is a basket of securities like stocks, bonds, commodities etc. These funds track an index, or a commodity, or a pool of assets. Since they are traded on the exchange, one can buy or sell them through a brokerage firm. Their price changes throughout the day due to trading.
How ETF Works?
ETFs pool money from the investors, individual or corporate, and invest it in either of stock indices, commodities, currencies, bonds, or any other asset class. These funds divide ownership of itself into shares that are held by the shareholders (investors) and these shareholders indirectly own the asset of the fund. Shareholders are entitled to the share of profits in form of interest or dividends. When the fund is liquidated or matured, they get the residual value of their shares.
Types of ETFs
There are following popular types of ETFs:-
- Index ETFs: These types of funds track an index, Ex. Nifty 50.
- Commodity ETFs: These funds invest in commodities. Ex. Gold ETF.
- Bond ETFs: In this type of fund, capital is invested in bonds.
- Currency ETFs: These funds invest in currencies.
Advantages of ETFs
ETFs have the following advantages:-
- Can be bought and sold at any time throughout the day during market hours.
- The minimum investment is 1 unit.
- The investor need not pay fees to the fund manager.
- Control over capital gain tax.
- Allows diversification of stocks and indices.
ETFs Vs Mutual Funds
| Exchange Traded Funds (ETFs) | Mutual Funds | |
|---|---|---|
| Trading | Traded on Exchange | Not traded |
| Price Update | Price is updated throughout the day | Price is updated after the closing of the market |
| Operating Expense | Lower | Varying (typically higher) |
| Taxation | More Efficient | Less Efficient |
| Transparency | Disclose asset holding daily | Asset holding not disclosed daily |
| Minimum Investment | Very low | Higher as compared to ETFs |
| Redemption Penalty | No penalty | 1% exit load if redeemed within 1 year in many MFs |
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