Exchange traded funds have revolutionized the investment market and are also known as “Legos of the investment world.” These vibrant investment vehicles offer an astonishing range of asset classes with a diverse investment portfolio and niche trading strategies. ETFs allow you to invest in everything under the financial sun in building a customized portfolio, and can readily be traded like stocks through your brokerage account. It is also an attractive option for the newbie investors, as it does not let you dwell into the complex analysis paralyses to decide on various investment alternatives. When you buy an ETF, you actually invest in buying all the stocks that are included in the investment basket without having to buy each of them separately. Just like stocks ETFs are also traded throughout the day and can be regulated through stockbrokers’ platforms.
Now, one of the most common questions that we are often asked is,why to invest in ETFs when they act and seem exactly like an ordinary stock?
Let us zoom in a little more to have clear insight about what goes behind the scene.
ETFs provide a wide variety of access to the top companies and each ETF is a fund that enables you to have the most alluring portfolio of different shares, bonds, and other instruments. With Stock ETFs you get to have the opportunity of gaining exposure to hundreds of shares of different companies without taking the toll of much risk either. The high level of transparency for both holdings and the investment strategy, enables investors to evaluate potential risks and return which also extends a great help for the new investors. It mainly features to track specified benchmark or index of securities. There is an underlying Net Asset Value (NAV) that is updated on the trading software to help investors in making wise decisions to buy or sell the units. Like other stocks, the price of an ETF may fluctuate 7.5% on either side up or down every day, starting from the face value of Rs. 10 per unit. Authorized Participants (APs) are designated to create and redeem ETFs, Asset Management Companies (AMCs) assemble the required portfolio of asset component and turn the basket over to the fund in exchange for numerous newly created ETFs. Later, when there is a need of redemption, APs return the ETF shares to the fund and receive the portfolio basket.
ETF’s VS Mutual Funds
Investors have long looked for a variety of ways to expand their investment horizons and always come up with a number of innovative options to gain most out of their investments. Whereas ETFs abbreviation of Exchange Traded Funds differ in a lot of ways from mutual funds. Mutual funds also contain various stocks, bonds and other assets but they are supposed to be selected individually from the investment basket and are actively managed by a fund manager. While, ETFs let you participate without bearing the expense or risk of buying an individual share, because through ETFs the actual investment in a company is in fractions and if the index goes down for a specific company, it would obviously cost in fraction out of the whole portfolio or investment. This approach helps in mitigating the risk along with extending the benefit of spending minimum time in managing the portfolio. An ETF is structured like an index fund whereas it is traded like an individual stock. As for index fund, you cannot take advantage of the market movement during the trading day.
Cost plays an important role in planning for an investment decision. It is higher in Mutual funds because of the active management approach, which requires to have a full time fund manager. However, ETFs are known as passively invested assets that feature slow cooker approach of investing that mirrors the concept of “Set and forget it.” The inherent factor of diversification in ETFs will heighten the chances of steady growth. For passive investors, ETF is an appropriate option to invest in the financial market that does not require to gather ample information about each and every stock individually before making a buying decision. So, whatever type of fund you choose, the investment decision comes down with a priority of individual investors about what they value most to honor their financial goals.
A quick rundown
The chart below will give you a quick sweep in a glance about Mutual fund vs ETFs
Exchange Traded Funds | Mutual Funds |
|---|---|
Traded through stock broker/dealers | Traded through numerous channels |
Listed on stock exchange | Not listed on stock exchange |
Capital gains are reinvested and may distribute the capital gain if make-up of the underlying assets is adjusted | Capital gains within the funds are distributed to the shareholders |
Dividend is redeemed to the brokerage account | Dividend may be reinvested automatically |
It requires passive trading approach | Active trading approach is required |
Low management fees | High management fees and total expense ratio |
Benefits of ETFs
One of the biggest draws for investors contemplating ETFs benefits is the ease of use and trading. It provides ease of trading for the new investors, who are willing to participate in the financial investment games but too apprehended due to the lack of expertise. As investing in ETFs does not require the investment decision for the individual stocks. ETF benefits the investors in opting for the investment option with a passive approach and rest is managed by the expert managers functioning at the back end on the entire mechanism.
The flexible nature of the unique investment vehicle allows the convenience of trading at any time of the day, as the price changes or varies throughout the trading session. Also, ETFs are traded on exchanges due to which it features high liquidity, and can be bought and sold whenever needed on an urgent basis.
While trading ETFs you can enjoy the feature of diversity that makes it less risky than any other investment vehicle, it also allows you to have a diverse portfolio of a gamut of stocks of different companies. If for instance, the stock of any one company is not performing better it would not affect you much because of the advantage you receive while trading in a diverse portfolio.
Accelerating to new heights
As soon as these innovative investment products made their entry into the financial market of Pakistan, it gained unprecedented popularity among investors while offering massive opportunities to the new investors as well. ETFs are firmly establishing an investment vehicle that will continue to grow and become a game-changer in the financial world. Using ETFs to piece together the portfolio in the most dynamic way allows the investors to sync in with the dramatic changes in the investment market. Nevertheless, the unique features of ETFs attracts many financial advisors and investors to opt for it as a trading vehicle over other available investment tools. ETFs essentially make it much easier to trade a big group of stocks at once and diversify the entire basket of securities whilst avoiding tax consequences. Thus, instead of hiring a full-time fund manager who would actively pick stocks to maximize profits, these ETF funds would simply replicate fund indices which gave a room for further slashing the overhead cost. Therefore, understanding the interaction between ETFs, cash equities and derivatives has become pivotal to comprehend the range of market participants. The rapid popularity of ETFs is going to enter the new arenas of success that will reshape the whole financial dynamics in the long run.