All of you are familiar with ETF (Exchange Traded Fund), a basket of securities that are listed and traded on a recognized stock exchange. Simply put, they are mutual funds, whose units can be bought and sold on the stock exchange. Exchange Traded Funds (ETF) can be either passively managed or actively managed. Understanding of the advantages and disadvantages of Exchange Traded Funds (ETF) will help you to take a prompt decision to invest on this instrument. Below are the same.
Advantages of ETFs
1. Exchange Traded Funds (ETFs) tend to be more cost-effective compare with mutual funds. For instance, while the expense ratio of a passively managed Exchange Traded Funds, ETF, (tracking a benchmark index) would normally be in the range of 0.50%-1.00%; for an Index mutual fund, it can be go high up to 1.50%.
2. Exchange Traded Funds (ETF) providing more flexibility to investors than regular mutual funds. Since they are traded on the stock exchange, investors can buy and sell Exchange Traded Funds (ETF’s) at any time during the exchange trading hours. So investors can buy and sell units of an Exchange Traded Fund (ETF) on a real time basis, unlike regular mutual funds, which can be transacted only at end-of-day NAV (Net Asset Value).
3. Since Exchange Traded Funds (ETFs) witness most of the buying/selling on the exchange, the interests of the long-term investor are not compromised. Take a regular equity fund where units are bought and sold at the AMC’s (Asset Management Company) end – when a significant amount of money enters and exits the fund rather quickly, the long-term investor could suffer as a result of the costs (trading costs, registrar costs and opportunity loss, if the fund manager is forced to sell his best stocks) associated with this quick inflow/outflow.
With an Exchange Traded Fund (ETF), an investor don’t required to approach an AMC (Asset Management Company) and only interacting with other investors over the exchange, his quick entry/exit does not compromise the interests of the long-term investor.
4. Given Exchange Traded Funds (ETFs) are traded on the stock exchange, and can be bought/sold on a real time basis; they tend to have low tracking error (deviation of ETF’s performance from that of the underlying index) as compared to index funds.
Disadvantages of ETF
1. The main requirement to subscribe the Exchange Traded Funds (ETFs), an investor should have or open a online dmat account with any reputed stock broker. Like any other exchange traded stocks, Exchange Traded Fund (ETF) also in the dematerialized for and can exchange through on online trading account. Here, mutual funds sends the statements and certificates in paper form and can take those to the mutual fund office for redemption of the units.
For investors, who do not trade in stocks, this could be a bit of a deterrent. Also, maintaining a demat account entails paying annual fees depend on stock brokers. investors, who invest in stocks, this will not pinch as the maintenance charge of the demat account will be spread across the stock and ETF investments.
2. While investors have to incur entry/exit loads at the time of making/redeeming investments in mutual funds, for Exchange Traded Funds (ETFs) they have to pay a standard brokerage to the stockbroker, along with other applicable charges, every time Exchange Traded Fund (ETF) units are bought or sold. For a trader who frequently trades, this can have a significant impact on the net returns. But for long-term investors, these expenses hold little relevance.
As an investor, what you can do?
It is evident that Exchange Traded Funds (ETFs) offer a different investment proposition compare with conventional mutual funds. ETFs may appeal to investors who want to track the performance of a particular benchmark index; similarly, the ETF route can also appeal to investors who are desirous of investing in asset classes such as gold. The allure of ETFs will only grow given the expanding bouquet of offerings.Investors on their part would do well to thoroughly understand the pros and cons of ETFs; this will help them make informed investment decisions. Also, investors must consult their investment advisors/financial planners to determine the suitability of an ETF in their investment portfolios.