Exchange Traded Funds or ETFs have emerged as a popular investment vehicle globally as well as in India in recent years. ETFs provide several benefits over traditional mutual funds. However, many investors are still not fully aware about etf and why they should consider them. This article discusses top 5 reasons why investing in ETFs makes sense for building an effective investment portfolio. Some of the key advantages covered include low costs, instant diversification, tax efficiency, liquidity and transparency. Let’s take a closer look at these benefits in detail.
- Low Cost
One of the key benefits of investing in ETFs is their low cost structure. ETFs have much lower annual fees than actively managed mutual funds since ETFs are passive funds that simply track the performance of market indices. They do not require fund managers to actively research and pick stocks. This makes the cost of owning ETFs quite low. For example, the total expense ratio of Nifty ETFs is around 0.1-0.2% compared to 2-3% for many actively managed equity mutual funds. These lower costs are retained by the investor annually, providing higher returns in the long run compared to actively managed funds charging higher fees.
- Diversification
ETFs allow investors to achieve instant diversification of their portfolio at a very low cost. A single ETF can provide exposure to a whole index or sector. For example, investing in an Nifty 50 ETF gives exposure to all the 50 largest and most liquid stocks on NSE. This diversification reduces portfolio risk. Investors do not have to spend time and money building well diversified portfolios on their own.
- Tax Efficiency
ETFs enjoy certain tax benefits compared to regular mutual funds. Profits from selling ETF units are taxed only if units are sold before completion of one year from purchase. Index ETFs also enjoy lower capital gains tax of 10% compared to 15-30% for debt and equity mutual funds respectively. This makes ETFs more tax efficient over the long term.
- Liquidity and Flexibility
ETFs are traded on stock exchanges throughout the trading sessions. This allows investors to buy and sell ETF units anytime at current market price, just like stocks. There is no lock-in period. This flexibility is not available with mutual funds which can only be purchased and redeemed at end of day NAV. ETFs also settle quicker (T+2 days) than mutual funds (T+3 days) providing higher liquidity to investors.
- Transparency
ETFs are very transparent investment vehicles. Their portfolio holdings and composition is disclosed regularly on fund house websites. This allows investors to know exactly what they are investing in. In contrast, mutual fund disclosures are not very frequent or timely. ETFs follow a passive strategy of tracking indices so there are no surprises regarding stock selection or sector tilts.
Conclusion
ETFs offer 5paisa investors an easy, low cost and transparent way to build diversified portfolios. Their tax efficiency and liquidity make ETFs ideal for both short and long term goals. With growing choice of ETFs tracking different indices and sectors, they should be considered as core holding in one’s investment portfolio. Regular investing in ETFs can help meet various financial goals in a simple yet effective manner.
