Investing in an ETF

Till a couple of years back, mutual fund schemes were generating superior returns in three and five-year period on a trailing basis. Nevertheless, as of now, even the best of the schemes are generating returns in single digit since the last three years. As returns generated by equity moves in a cycle, we may see the next few years to be very good from a return perspective.

Most of you, however, are not sure where to start investing. ETF is one such place you can start with.

For beginners, ETF or exchange-traded funds are essentially index funds that are listed and traded on stock exchanges just like stocks. An ETF is a basket of stocks that imitates the composition of an Index, like Nifty 50.

ETF Schemes

ETF is not limited only to equity instead; there are ETFs that have debt instruments as underlying:

Different ETF Schemes launched on NSE are:

Equity: Based on equity indices like Nifty 50, Nifty Bank, S&P BSE Sensex, Nifty Mid-cap etc.

Debt: Based on indices like Nifty 8-13 yr, G-Sec Index, Government Securities etc.

Gold: Based on gold prices and invests in gold bullion.

World Indices: Based on international indices like HangSeng, Nasdaq 100 etc.

Thus, you have an entire gamut of the asset class to invest through ETFs.

ETF Composition

A particular ETF invests in securities in the same proportion as the underlying index.

For example, Nifty 50 ETF will invest in 50 stocks comprising Nifty 50, most likely, in accordance with the weight of individual stocks in the index.

Benefits of Investing in ETFs

ETFs trades just like any other listed company shares on a stock exchange and provides diversification of an index fund as well as the flexibility of a stock. The returns generated by ETFs are almost exactly in-line with the index with a minor difference. Like stocks, you can short-sell them, buy them on margin and purchase as little as one share.  ETFs are traded in real-time thereby, offering more liquidity. It is a passive way of investing where the risk of the fund manager's discretion is eliminated.

Picking the right ETF

Will all the benefits of investing in ETF listed above, you should carefully select the ETFs, whose underlying asset has ample liquidity. Besides, you should also check the tracking error, which should be less, so as to follow the performance of an index as closely as possible. In addition to that, ETFs should have a lower expense ratio and sufficient volume of trades on a daily basis as it indicates liquidity.