Investing in an Exchange-Traded Fund (ETF) is a low-cost way to achieve diversification and build a strategic portfolio in 2022. An ETF is essentially a basket of securities that combines the benefits of stocks and mutual funds. It is a type of pooled security like a mutual fund that tracks a particular index, commodity, sector, or asset and its shares are bought and sold in the stock market so you can invest in them the way you invest in regular shares. But before you invest in an ETF this year, here are some factors you should consider.
- Types of ETFs to buy
When you consider what the best ETF to buy in India is, you should first know the types of ETFs that exist. Primarily ETFs are of three types – equity ETFs, debt ETFs, and gold ETFs. Equity ETFs are the most popular types of ETFs in the country, and they invest in the stocks of various companies. Debt ETFs invest in fixed-income securities such as corporate bonds, government bonds, treasury bills, etc., while gold ETFs track the domestic price movements of gold. When you buy gold ETFs, you are investing in electronic gold that is backed by physical gold bars of 99.5% purity.
- Trading activity
When looking at ETFs to buy, make sure you look at their trading volume. That’s because while the popular ETFs may have a high trading volume that runs into millions of shares a day, some other ETFs may barely trade at all. The higher the trading volume, the more liquidity you have. Higher liquidity also ensures a tighter bid-ask spread.
- Tracking error
It’s essential to check the underlying asset or index that the ETF you are investing in tracks. For instance, an ETF that tracks a broad-based index will provide more diversification and come with lower risk than an ETF that tracks a niche sector. Once you have looked into the underlying index or asset of the ETF, you should also check its tracking error. While ETFs aim to mimic the performance of their underlying index, not all of them are able to track it as closely. The best ETFs to buy in India are going to have a minimal tracking error.
- Expense ratio
One of the biggest advantages of ETFs is that they come with a low expense ratio as they are passively managed funds. For instance, the expense ratio of actively managed mutual funds tends to be higher because the fund manager has to constantly analyze the market conditions and buy, sell or hold the underlying securities accordingly. However, with ETFs, the role of the fund manager is minimal as this investment product is designed in a way that simply tracks the underlying asset or index. Most ETFs have an expense ratio that is less than 1%. Make sure to check the expense ratio of the ETFs you are looking to buy.
ETFs make for great additions to an investment portfolio that is looking for higher diversification at lower costs. However, it’s important to remember that ETFs are not risk-free and are impacted by market volatility, which can lead to widening bid-ask spreads. Hence, your portfolio should have a mix of investment products that have different risk-return profiles and follow different strategies including passive management and active management. How much you should invest in an ETF and the types of ETFs you should invest in will depend primarily on your financial goals, risk tolerance, and current investment portfolio.
