Five Good Reasons To Invest In Exchange Traded Funds (ETFs)

Saturday, 10 July 2021, 5:32 am
Press Release: Kalkine

Summary

• ETFs have emerged as a popular choice of investment during the COVID-19 era.
• During the virus crisis, investors increasingly turned to ETFs to hedge portfolios, efficiently rebalance holdings and manage unprecedented risks.
• While there are some valid reasons to invest in ETFs, it is imperative to understand the particulars and risks of ETF investing before taking exposure to this domain.

Most of the investors primarily enter into the equity market to create wealth. However, wealth creation is a long journey, and despite having an almost similar goal, the path often differs for different investors. While there are numerous ways to amass decent wealth from the stock market, investors need to figure out their own path depending on their individual goals and time horizon.

For some investors, direct equity investments might make more sense to enter the stock market, while for others, investment funds like Exchange-Traded Funds (ETFs) could be an ideal way to do the same.

For the uninitiated, an ETF is a kind of investment fund, which trades on a stock exchange and tracks an underlying index. The sole purpose of an ETF is to deliver a return as close as possible to its underlying assets. Interestingly, ETFs have emerged as a popular choice of investment during the COVID-19 era, given the resilience and robustness demonstrated by these funds over the last year.

Must Read: What made ETFs a Star Investment Opportunity During COVID-19 Crisis?

ETFs were seen to be successfully navigating an episode of extreme market volatility during the pandemic while serving their function as risk-transfer mechanisms, investment vehicles and price-discovery beacons. Investors increasingly turned to ETFs to hedge portfolios, efficiently rebalance holdings and manage unprecedented risks during the virus crisis. While not all ETFs were able to pass the COVID-19 stress test, most of them proved their resilience in the pandemic-induced uncertainty.

Having said that, there are some good reasons for investors to diversify from their regular equities and take exposure to ETFs, as discussed below:

Trading Flexibility

ETFs, as the name suggests, are openly traded on a recognised exchange. It implies, they can be bought and sold during the market hours at the desired prices. Unlike mutual funds, where an investor needs to wait for the end of the day to get the net asset value (NAV), ETFs can be instantaneously added to or removed from the portfolio akin to shares.

The continuous price mechanism of ETF provides investors with multiple real-time exit and entry points, allowing them to trade any number of times during the market hours.

Lower Costs

The cost has been an important factor in determining the net returns of an investment. Notably, the fees charged to investors buying an ETF are typically lower than fees charged for mutual funds. There are negligible commissions or management fees involved in ETFs, making them relatively cheaper than mutual funds.

Besides, investors can easily avoid the accumulation of commission fees in ETF trading as there is only one transaction per trade, unlike regular equity trading when you add a basket of stocks to your portfolio. This low expense ratio associated with ETFs helps to boost investors’ returns while ensuring long-term gains.

Diversification

Diversification is one of the most popular and probably the simplest ways to manage risk at the portfolio level. With numerous stocks trading in a single ETF, investors can cut down the concentrated risk of any single security. In fact, ETFs based on indices are the best example of diversification.

Moreover, ETFs are now trading on virtually every significant asset class, currency, and commodity across the world, allowing investors to gain exposure to different segments. Meanwhile, ETFs are also allowing investors to access global markets, taking diversification levels a notch higher.

Tax-Friendly

ETFs are believed to hold a tax advantage over mutual funds as the underlying assets are traded less frequently, and investors can choose when to prompt those taxes by actualising the gains.

Notably, the key tax benefit from ETFs arises from in-kind transfers. When investors or traders intend to sell shares in case of an ETF, they can eventually be redeemed in kind with authorised participants who redeem and create ETF units. This process usually avoids any cash sales and consequently makes ETFs highly tax efficient.

Sophisticated Investments

In the world of ETFs, there is a category called Exotic ETFs, which are primarily much more complex and sophisticated than other investment options. These Exotic ETFs provides investors with an easy way to play with a large variety of more complex market, speculating and trading strategies. Some of these ETFs are Leveraged ETF, Inverse ETF and Equally weighted Index ETF. While these investments generally carry higher risk, they can potentially magnify investors’ returns by two or three times.

No doubt, ETFs have established their position as a great investment vehicle for passive and active investors alike. However, investors must understand the particulars and risks of ETF investing before taking exposure to this domain. Remember, while ETFs are low-risk investments, they are also subject to risks of their underlying securities and market volatility, which should be carefully considered when making investment decisions.

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