Beginners Guide to Investing in ETFs

Published On: 07-May-2019

Exchange Traded Funds, commonly referred to as ETFs, are the mutual funds which track the underlying index with an intent to replicate its performance for the investors. So, if the underlying index moves by 15% in a year, an ETF tracking the index will generate similar returns for its investors (less the expenses). As such investing in ETFs allow the investors to have direct investment exposure to popular indices like S&P BSE Sensex, Nifty50, Nifty Next50 etc.

 

Benefits of Exchange Traded Funds (ETFs)

 

Why invest in ETFs?

ETF Benefits for investors include the following:

1.Lower costs

Since the ETFs are passively managed, the investment and fund management team only needs to track the underlying index and implement the changes whenever they happen. There is no flexibility with the fund manager to deviate from the index weight, than that of the underlying index. Therefore, ETFs tend to have lower expense ratios than actively managed funds.

2.Elimination of unsystematic risk

The investment risk is classified into two categories – systematic risk and unsystematic risk. Systematic risk refers to the broader market risks, which is the risk of movements in the equity markets due to changes in the macroeconomic environment. On the other hand, unsystematic risks are the risks which are specific to the specific investment option, i.e. the select mutual fund scheme. ETFs only carry the systematic risk, since they replicate the market indices and to some extent, the risk of tracking error, which means the time gap between the time changes are implemented in indices and when the changes are made effective in ETF portfolio. As such, investors may use ETFs to eliminate unsystematic risk in their portfolio effectively.

3.Diversification

Since the underlying indices are constructed after adequate research and back-testing of data, they encapsulate different market sectors and segments within the same index. Investing in ETFs provide the same diversification across the market segments to the investors.

4.Liquidity

Since the ETF units are listed on the recognised stock exchanges, the investors may liquidate their investments at any point of time during the exchange trading hours.

How to Invest in ETF?

ETFs are listed on a stock exchange, and thus, they may be traded in the same way as an equity share. The investors may buy/ sell ETF through their demat trading accounts by placing a bid for purchasing the units at market price or the limit price. A limit price order gets executed if the market price of the ETF units touches or goes below the limit price. Further, such units may be held by the investors only in their demat accounts.  

ETFs vs Index Funds

While both the ETFs as well as index funds are passive investment products, here is a brief comparison between the two:

 

   Features

  ETFs

   Index Funds

Market Price/ Net Asset Value (NAV)

Available real-time at stock exchange platforms

Calculated by the mutual fund house at the end of the day

Units are be bought/ sold through

Stock Exchanges

Mutual Fund

Portfolio Disclosure

Daily

Monthly

Holding

Compulsorily in demat form

Physical + Demat

 

Taxation of ETFs

The taxation of ETF units is dependent upon the underlying index. If the underlying index is an equity index, the taxation will be in line with the tax treatment for equity shares, where any short-term gains (with an investment period of less than 12 months) are taxed at 15% (plus applicable cess and surcharge) and the long-term capital gains are taxed at 10%. Such long-term capital gains are also exempt up to Rs. 1 lakh a year and only gains beyond Rs. 1 lakh are taxable.

Considering the transparency embedded within the ETF as an investment product and its lower cost of investing, ETFs mays be considered by the investors who are willing to stay content with the broader market indices’ returns and are not running for the alpha-generating mutual fund schemes.

Disclaimers: The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is advised to consult his or her or their own tax consultant with respect to specific tax implications arising out of their participation in the Scheme. Income Tax benefits to the mutual fund & to the unit holder is in accordance with the prevailing tax laws/finance bill 2017. Any action taken by you on the basis of the information contained herein is not intended as on offer or solicitation for the purchase and sales of any schemes of UTI mutual Fund. Please read the full details provided in SID and SIA carefully before taking any decision.

UTI AMC Ltd is not an investment adviser, and is not purporting to provide you with investment, legal or tax advice. UTI AMC Ltd or UTI Mutual Fund (acting through UTI Trustee Company Pvt. Ltd) accepts no liability and will not be liable for any loss or damage arising directly or indirectly (including special, incidental or consequential loss or damage) from your use of this document, howsoever arising, and including any loss, damage or expense arising from, but not limited to, any defect, error, imperfection, fault, mistake or inaccuracy with this document, its contents or associated services, or due to any unavailability of the document or any part thereof or any contents or associated services.