For those who do not know, mutual funds are broadly categorized as actively managed funds and passively managed funds. Active funds are those mutual funds where the fund manager is actively involved in buying and selling securities so that the portfolio is able to favor the existing market conditions. It is the responsibility of the fund manager to ensure that the portfolio is maintained and minimize the portfolio’s overall risk exposure. On the other hand, there are passively managed funds where the fund manager is only involved in structuring the portfolio and designing it in such a way that the scheme is able to generate returns by mimicking the performance of its underlying benchmark. Index funds and exchange traded funds are such passive funds that investors consider diversifying their investment portfolio with.

Today we are going to discuss exchange traded funds some of the pros and cons of investing in these passive funds.

What is an Exchange Traded Fund?

Commonly referred to as ETFs, an exchange traded fund is an open ended mutual fund scheme that can be bought and sold at its current live market price. Exchange traded fund units can be bought and sold just like company stocks. These are the only type of mutual fund schemes that are listed at almost every stock exchange.

What are some of the pros and cons of investing in exchange traded funds?

First, we’ll take a look at the pros and then later at the cons.

The biggest advantage of investing in an exchange traded fund is that investors do not have to worry about the investment decisions taken by the fund manager. Here, the error for human biases is nil as the fund manager does not trade with the underlying securities of an ETF. An exchange traded fund is designed in such a way that it tries to replicate the performance of its underlying index and hence generates returns with minimum tracking error. Thus, those who do not wish their portfolio to be constantly shuffled can consider investing in exchange traded funds.

The second advantage which ETFs having other active funds is that investors can enter or exit these funds throughout trading hours. This is more convenient than other mutual funds where the investor has to place a request to the fund house, and they can either buy or sell units based on the NAV that is determined at the end of the day. Since the current live price of an ETF is available to investors, it makes buying and selling ETF units simpler.

ETFs can be a great way for investors to get exposure to how equity markets function. Investors who wish to invest in stocks but are still not quite sure about how to go about it can start with ETFs. Since ETFs invest in a diversified portfolio of securities belonging to the same benchmark, they avoid concentration risk.

Investors can even start a monthly SIP in exchange traded funds. A Systematic Investment Plan or SIP is a simple and easy way to ensure that you save and invest a fixed sum regularly in mutual funds. A Systematic Investment Plan or SIP is a simple and effective way to build long term wealth with ETFs. Investors can even use the SIP calculator to get an estimate on the total returns earned through SIP.

Now coming to the cons there aren’t any except for the fact that investors need a demat account to hold their bought ETF units. Unlike other mutual fund units that can be brought through a regular demat account, one cannot trade in ETF units unless they open a demat account.