Finance

What exactly is ETF? Definition and meaning

Nifty and Sensex are two words that we cannot ignore. The same gets bombarded to us through news outlets and finance enthusiasts every day. But what are they? They are stock market indexes. They are a way to gauge the overall performance of the stock market. They do this by creating a list of the top and the most influential stocks of the stock markets and following their growth collectively.

Nifty and Sensex, the two indexes that contain the top stocks in India, have grown more than 75% in the last five years, as of September end, 2022. This represents the overall growth of the stock market. But how do you take advantage of this growth?

You could do your research and create a portfolio similar to that of the indexes. But this is often hard work and requires a significant amount of corpus as each stock may cost a lot. Exchange-traded funds (ETFs) are something you can consider here. Let us learn more about ETFs in detail through the article. 

What are ETFs?

An ETF is similar to a mutual fund. There will be a fund manager that pools money from different investors to invest in a portfolio. But the main difference is that here the portfolio is not designed by the fund manager but rather is auto-created as it follows an index as it is.

Simply, let us assume you are investing in an ETF that follows Nifty. The Nifty consists of 50 components. The ETF that follows nifty will have the same 50 components. Hence, the ETF tries to replicate the growth of the index.

The main difference between an ETF and a mutual fund is liquidity. ETFs are traded in the stock market, similar to that stocks. This ensures higher liquidity. 

Types of ETFs

We have discussed how beneficial equity ETFs are in the above section. But ETFs are not limited to equities alone. Below is the list of types of equities.

Index ETF

Index ETFs are the types of ETFs that we have discussed above. They follow or track an index to mimic the performance and growth of the index. Index ETFs are the most popular as well.

Gold ETF

Gold is one of the popular investment options in India, and there are many ways to invest in gold online today. Gold ETFs are one such method. They trade in the stock market according to the price of 24-carat gold. You gain as an investor when the gold price increases.

Bank ETF

Coming back to equity-based ETFs, bank ETFs invest exclusively in banks and other financial company stocks. To achieve this, bank ETFs may follow bank indexes.

International ETFs

The stock market is not limited to India. But when you want to try out international stocks, one thing that could come in the way of things is the bias of the fund manager involved. ETFs could be a solution here as they follow a global index as it is.

Liquid ETF

Liquid ETFs, as the name suggests, invest in the most liquid securities. This includes money market instruments and currencies.

Conclusion

There are many reasons why ETFs are a good investment option. To begin with, you get to invest in a fund that has less bias and is passively managed. Due to the same reason, it comes with a lower expense ratio as well since the role of a fund manager is limited. But ensure you compare the potential of ETFs with your goals for the best results.

 

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