WHAT IS AN EXCHANGE-TRADED FUND? As the name suggests, this is a fund but it can be traded on an exchange like a security. In simple words, an ETF is a basket of securities like any other mutual fund, but is tradeable, that is, it can be bought or sold like a stock. So, you own a share of the fund, but not the underlying securities that the fund holds.
An ETF typically tracks an index, bond, commodity or an index fund. While most ETFs are passive like an index fund and some are actively managed. ETFs can be of various types depending on the securities they hold, such as equity, fixed income, commodity and sectoral, among others. ETFs are usually cheaper than buying individual stocks and are more liquid than mutual funds.PROS & CONS OF ETF INVESTING Benefits Lower cost: Since most ETFs are passive, the operating costs are lower. The brokerage fee will also be lower compared to buying and selling individual stocks. Liquidity: Unlike a regular mutual fund, an ETF can be traded at any time during trading hours. Less risk and effort: It’s easier to achieve the required asset allocation due to diverse assets in a single fund. If the ETF is tracking an index, it eliminates unsystematic risk and minimal effort is needed to earn market-linked returns over the long term.Drawbacks No outperformance:Since most ETFs track indices and are not actively managed, the returns are aligned to the indices and there is little scope of earning higher returns. Illiquidity: In thinly traded ETFs, it may be difficult to sell a fund and liquidity may become an issue when you need the money. Tracking error: An ETF can deviate from its benchmark index for various reasons, resulting in performance that is not aligned with the index.
