An exchange traded fund (ETF) is a basket of securities i.e. stocks, bonds, commodities or some combination of these. ETF offer diversification benefits of mutual funds while mimicking the ease with which stocks are traded. An ETF is a basket of securities that you can buy or sell through a brokerage firm on a stock exchange.
ETFs are designed to track the value of an underlying asset or index. If the price of one or more asset rises, the share price of the ETF rises proportionately, and vice-versa. They trade at market determined prices that usually differ from that asset. Because of things like expenses, longer-term returns for an ETF will vary from those of its underlying asset. Dividend received by the share-holders of ETFs depends upon the performance and asset management of the concerned ETF company. Working of ETF
- An ETF provider creates a basket consisting of stocks, bonds, commodities or currencies with a unique ticker.
- Investors can buy a share of that basket, just like buying shares of a company.
- An investor trade the ETF throughout the day on an exchange, much like a stock.
Types of ETFs
Few common types of ETF are
- Market ETF : Track a particular index like the S&P 500.
- Sector and industry ETF : It provide a way to invest in specific companies within those sectors, such as the health care, financial or industrial sectors.
- Commodity ETF : Commodities are raw goods that can be bought or sold, such as gold, coffee and crude oil. It track the price of a commodity. Purchasing gold ETF allows you to become the owner of gold on paper, without the burden of asset protection.
- Foreign market ETF : Foreign stocks are widely recommended for building a diverse portfolio. International ETFs are less risky way to find these foreign investments.
- Equity ETF : These represent companies investing in shares and other forms of equity of various organizations.
- Debt ETF : Enterprises trading in fixed return securities such as debentures and government bonds.
- Currency ETF : It mainly profit due to the fluctuation of the exchange rates.
ETF vs Mutual Fund
- ETFs have lower fees than mutual funds. There are various charges involved in mutual funds, such as entry and exit load, management fees, etc. This increases total cost incurred, and thereby the total expense ratio of mutual funds. As ETFs are traded like shares in the stock market, its expense ratio is considerably lower.
- ETFs are increasingly popular, but the number of available mutual funds still is higher.
- Value of a mutual fund depends upon the performance of the NAV and can only be determined after the market closes for the day. Any changes in the value of an ETF can be observed instantly and can be bought and sold throughout the trading hours.
- ETF funds are more tax-friendly than mutual funds. Even though both are subjected to capital gains tax and dividend taxes, the relative amount of fee charged on ETFs is much lower than the one levied on mutual funds.