What are Exchange Traded Funds

Basically, Exchange Traded Funds (ETFs) are open-ended index fund that can also be traded on the stock market.

Compared to Mutual funds, there are many advantages of ETFs, one is real time pricing, secondly long term investors are protected from short term traders. Hence it proves to be an ideal instrument for both long term as well as short term investors and also it is easy to buy and sell from the exchange.

One major disadvantage of ETF is that the investor should have a demat account and a broking account.

There are two types of advantages over index funds – one is the expense ratio which is currently lower in ETFs as compared to normal index funds. The second advantage is the distribution costs- the other index funds have to pay trail commission to the broker, while ETF does not pay the same. So the ETF cost will be lower.

In addition to the above-mentioned expenses, there also exist some `hidden’ costs like transaction costs. Such costs do not form a part of the expense ratio like brokerage and STT. The transaction costs however, are incurred by index funds but not by ETFs. This is another area where ETFs score over regular index funds.

ETFs don’t incentivise their product, which other regular mutual funds can do, hence there is no one pushing it.

But internationally what has happened that over a period of time people have found out that ETFs are ideal instruments and it has become more popular.

In India the ETFs have outperformed the actively managed funds over the last year.

Even though the actively managed funds have done better on a 3/5 year scale, the net difference would be lower or non existent because of the higher cost. The active funds charge you 2-2.5% while the ETFs charge around 0.5% only. The extra Fund management charges will even out the difference, I guess.

I wonder why a good product like index funds does not sell like hot cakes. Comparatively an expensive product like ULIP is selling like hot cakes even though it is much more expensive than the MFs??!!

I guess it boils down to lack of knowledge/information and that the agents have no interest in selling them.

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