Investing can be simple if the investor is well aware of his or her financial goals and knows the kind of risks, he or she can take with her finances to achieve the ultimate financial goal. Many investors blindly invest in an investment scheme by falling to marketing gimmicks and advertisement commercials. Others invest by looking at the past performance of the scheme. Please remember that if you are investing in a market linked scheme like the mutual fund, the scheme may or may not perform the same way as it did in the past. Mutual funds may hold the potential to offer long term capital appreciation, but they do not guarantee returns.

Having said that, if you know your goals and are able to choose the right type of scheme that ticks all the right boxes then you might be able to succeed in your financial journey.

Exchange traded funds are mutual funds that are publicly listed at the stock exchange. If you want to find out more about these funds, continue reading.

What is an exchange traded fund?

Abbreviated as ETF, an exchange traded fund is an open ended mutual fund scheme whose units are available for trading at their current live market price just like stocks of publicly listed companies. These funds invest a minimum of 95 percent of their total corpus in securities of their underlying index. For example, if an index fund tracks NIFTY 50 as its benchmark, then ETF fund will invest a minimum of 95 percent of the portfolio in equity and equity related instruments of companies listed under that index.

Factors to consider before investing in ETFs

Investors can go through the following factors surrounding ETFs to make an informed investment decision:

High liquidity: Unlike other mutual funds where the investor has to place a request with the fund house for carrying out transactions, ETF investors have full control over their investments. Here the investor can buy or sell the ETF units at their live market price during trading hours. Any ETFs that are largely traded throughout the day will have high liquidity.

Passive management: Mutual funds can be largely categorized as actively managed funds and passively managed funds. Active funds are those mutual funds where the fund manager buys and sells securities and maintains a diversified portfolio. On the other hand, passive funds like ETFs are designed to generate returns similar to the returns generated by the underlying securities of its benchmark with minimum tracking error.

Feasible expense ratio: The fund manager has very little say in how the ETF generates returns. The fund manager may reshuffle the ETF portfolio based on how the underlying securities in the benchmark change their composition. Since there is not much active participation by the fund manager, this makes an ETFs expense ratio relatively lower as opposed to active funds that have a high expense ratio.

Other costs: Although ETFs have a low expense ratio, investors must be aware of the other costs like transaction costs and demat account annual costs which they may bear for trading in ETF units.

Benchmark of the ETF: Investors must choose an ETF scheme based on the market segment to which they seek exposure. ETFs come in various forms viz., gold, international, banking, index based, debt oriented, etc. Do understand that different ETFs tracking similar benchmarks may still produce different results.

Investors need a demat account to hold their ETF units. Also, the mutual fund SIP option may or may not be available for ETF investment depending on the AMC of mutual fund aggregator you choose to invest with.