The most common assets that most investors look for are stocks, real estate, gold, and bonds. But the concept of investing in an exchange traded fund or ETF is rarely mentioned. Many investors I have interacted with who have been investing in the stock markets for decades had no idea when I first broached the subject of investing in an ETF. Their first question was “What is an ETF?” “
An ETF, generally, takes the full list of securities in a particular index and develops a basket with them in the same proportion as they are in the index. Unlike a mutual fund, an ETF trades on the index and can be bought and sold at any time during market hours. The price of an ETF fluctuates according to the net asset value (NAV) of the underlying basket of securities.
To invest in an ETF, you must first focus on the market in which you want to invest. The markets from the United States to India to others have ETFs of different kinds. After that, you can decide whether you want to invest in a larger index ETF or a sector specific ETF. For example, if you want to invest only in the metals sector, instead of picking and choosing specific stocks, you can invest directly in, say, Vanguard Materials ETF.
Liquidity is one of the most important aspects that you should consider before choosing an ETF. It is advisable to invest in ETFs with higher liquidity as they will have a lower bid-ask spread.
Does liquidity have a proxy? It does. This is in the form of assets under management (AUM). The assets under management of an ETF can be calculated by multiplying the outstanding shares by the market price per share. The assets under management of an ETF are subject to change. The higher the assets under management, the greater the liquidity of the ETF.
Another important aspect that you need to consider is the expense ratio. This is an annual fee levied by a fund to cover its expenses. For example, the Vanguard S&P 500 ETF has an expense ratio of 0.03%. This means that she uses 0.03% of her total assets to cover her expenses. The total expense ratio (TER) can vary from fund to fund, and a lower expense ratio does not guarantee high returns.
Since ETFs are not actively managed, they are also profitable compared to mutual funds. As they replicate the benchmark, the components are available for your review at any time.
In conclusion, ETFs offer multiple advantages and can certainly be considered as an investment option. The allocation may depend on your financial goals and investment needs.
The author is Chairman and CEO, Winvesta
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