What is an ETF, and how to diversify your portfolio via ETFs

portfolio via ETFs

What is an ETF?

Exchange-traded funds (ETFs), a type of pooled investment security, operate very similarly to mutual funds. ETFs frequently track certain industries, indices, commodities, or other assets; however, in contrast with mutual funds, ETFs can be traded or bought on a trading platform in the same way regular stocks can. An ETF can monitor anything, from the price of a specific commodity to a big and diverse group of securities. ETFs might even be created to adhere to specific investment philosophies. ETFs often cost less and are more liquid than mutual funds.

Following their widespread debut in the early 2000s, exchange-traded funds or ETFs, saw a phenomenal boom that has persisted. For investors with the question “what is an ETF?”, it is important to note that the advent of said investment vehicle was always great because it has opened up new low-cost alternatives for almost all market asset classes. For the weekend investor, sorting through the more than 5,000 ETFs currently offered internationally is daunting.

Types of ETF

Investors have access to various ETFs that can be utilized to create income, indulge in price appreciation and speculation, and manage risk in their investments. If you intend to build an ETF-only portfolio, be careful to include a variety of asset classes to provide diversity. For instance, you may start by concentrating on the following areas:

Active and Passive ETF

ETFs fall into the categories of actively managed and passively managed. Passive ETFs are designed to imitate the performance of larger indices, whether they be more narrowly focused sector or trend indices or more diversified indices like the S&P 500. As of February 18, 2022, approximately eight ETFs focused on companies involved in gold mining, excluding leveraged, inverse, and funds with small assets under management. Gold mining stocks are an example of the last type (AUM).

  • Bond ETF: Bond ETFs are made to provide investors with a reliable income. The performance of the underlying bonds determines their income distribution. Among them could be state and local bonds, business bonds, municipal bonds, and government bonds. Like its underlying assets, bond ETFs don’t have a maturity date. They frequently fluctuate above or below the underlying bond’s price.
  • Stock ETF: Stock (equity) ETFs are made up of a group of stocks that follow a particular sector or industry. For instance, a stock ETF may track stocks in the international or car industries. The aim is to give a single industry with established players and up-and-coming competitors with development potential a variety of exposure. In contrast with stock MFs, stock ETFs are less expensive.
  • Sector/Industry ETF: Funds concentrating on a particular industry or sector are known as industry or sector ETFs. For instance, an ETF for the energy sector will include businesses engaged in that industry. By tracking the activity of the companies that make up their constituent ETFs, industry ETFs are intended to provide investors with access to an industry’s prospective growth. The recent flood of capital into the IT sector is one example.

ETFs mitigate the negative effects of irregular stock performance because they do not require direct ownership of shares. Industry ETFs also cycle into and out of sectors during economic cycles.

  • Commodity ETF: As their name implies, commodity ETFs invest in commodities such as gold or crude oil. Commodity ETFs have a variety of benefits. A portfolio is initially diversified, which makes it easier to manage downturns. These funds, for instance, might provide support when the stock market is falling. Second, purchasing a commodity directly becomes more expensive than making an investment in a commodity ETF. This prevents the first from needing to pay for storage and insurance.
  • Currency ETF: The progress of currency pairings, including domestic and foreign currencies, is tracked through currency exchange-traded funds (ETFs). ETFs that invest in currencies have many uses. They can be used to make currency price predictions based on a nation’s political and economic trends. Importers and exporters also use them to diversify their portfolios or as a safety net against foreign market volatility. Some of them are also used as hedges against inflation. There is even an ETF for bitcoin.
  • Inverse ETF: By shorting shares, inverse ETFs attempt to profit upon stock falls. Selling stock in expectation of a decline in value and then purchasing it back at a loss is known as shorting. An inverse ETF utilizes derivatives to short any stock. They are essentially bets against the market. Inverse ETFs gain value proportionately to a market decline. Investors should be aware that a number of inverse ETFs are not true exchange-traded funds (ETFs), but rather exchange-traded notes (ETNs). An ETN would be a bond even though it trades very similarly to stock and is insured by issuers like a bank.
  • Leveraged ETF: A leveraged ETF aims to return a number of times (such as two or three times) the returns of the underlying assets. These products utilize derivatives like options or futures contracts to increase their returns. Leveraged inverse ETFs are another option; they aim to generate an inverse multiplied gain.

Advantages and Disadvantages of ETF

As you plan on investing in global ETF in India, remember to take a look at its advantages and disadvantages as well:

Advantages of ETFsDisadvantages of ETFs
Potential tax effectivenessCommissions are to be paid to brokers
Trades made on an exchange throughout the entire dayCapital gains are occasionally distributed
Low expense ratioFlexibility might lead to more trade, which could counteract the tax-efficient benefit.
No set minimum investment amount. 
Can be acquired on margin and sold short. 

How to begin investing in ETFs

Trading on a variety of platforms has made investing in ETFs quite simple. To start investing in ETFs, adhere to the guidelines listed below.

  • Find an investing platform:

The majority of online investing platforms, websites that offer retirement accounts, and investing apps including Stockal, all offer ETFs. Most of these platforms allow commission-free trading, which means you can buy or sell ETFs without paying a fee to the platform’s operators.

However, a commission-free purchase or sale does not imply that the ETF issuer would also provide free accessibility to their offering. Convenience, product diversity, and services are a few ways platform services can set themselves apart from competitors. For instance, smartphone investment apps make it possible to buy ETF shares with a single button press. Not all brokerages will operate in this manner; some may require investors to submit papers or deal with more intricate circumstances. However, several reputable brokerages provide comprehensive educational content that aids new investors in learning about and researching ETFs.

  • Research ETFs:

Researching ETFs is the most crucial phase in the investing process. ETFs come in a huge range of options on the market right now. When conducting research, remember that ETFs differ from individual securities like stocks or bonds. When investing in an ETF, you must consider the sector or industry as a whole. During your investigation, you might wish to think about the following questions:

  • What time frame do you have for investing?
  • Do you invest for growth or income?
  • Do you have any favourite industries or financial products?
  • Consider trading strategies

Dollar-cost averaging or spreading out the investment fees over time, is a smart trading approach for new ETF investors. This is due to the fact that it spreads out gains over time and guarantees a disciplined approach to investing (as opposed to one that is haphazard or erratic). Additionally, it aids novice investors in understanding the specifics of ETF investment. Investors can advance to more complex tactics like swing trading or sector rotation as they gain trading experience.

  • Full-service Broker Vs Discount/  Online Brokers

ETFs can be traded through conventional broker-dealers as well as online brokers.

  • Full-service brokers: An investor would be better to use a full-service broker if they desire a close personal relationship with financial advisors at their brokerage firm. You may typically speak with internal professionals to assist you choose investments, undertake extensive financial planning, simply obtain an honest assessment when the market is more challenging than usual, or manage the tax repercussions of your investments. The cost is this type of broker’s drawback, though. Along the route, they impose steep fees, and some even impose high commissions, while others regularly take a tiny portion of your assets in payment.
  • Discount/ Online brokers: Investors’ equivalent of self-service stores would be online discount brokerage accounts. Although they typically leave you to it when it comes to selecting your investments, their biggest draw for investors is typically very low costs. Don’t hold your expectations too high when you locate bargain brokers that provide accessibility to advisors or investing research. Because let’s face it, you’re just paying peanuts, they probably won’t provide you with the same degree of accessibility that the full-service brokers provide.

What are some Popular ETFs?

Here are some of the most popular ETFs available right now. While some ETFs focus on particular industries, others track stock indices to build broader portfolios.

  • SPDR S&P 500 ETF, or the SPY: The “Spider” is the oldest and best-known S&P 500 index-tracking ETF still in existence.
  • The Russell 2000 small-cap index is tracked by the iShares Russell 2000 (IWM).
  • Technology firms often make up the Nasdaq 100 Index, which is tracked by the Invesco QQQ (QQQ) (“cubes”).
  • The 30 stocks that make up the Dow Jones Industrial Average are represented by the SPDR Dow Jones Industrial Average (DIA) (“diamonds”).
  • Oil, financial services, energy, biotechnology, and real estate investment trusts are just a few examples of the different businesses and sectors that are tracked by sector ETFs.
  • Markets for commodities such as natural gas, gold, crude oil, and silver are represented through commodity exchange-traded funds (ETFs).
  • Country ETFs follow the major stock indices of other nations, although these are traded in the US and are priced in USD. Brazil, China, Israel, and Japan, are some examples.
  • A broad range of overseas markets is tracked by others, including those that track developed market economies (EFA) and emerging market economies (EMEs).
  • All Popular NASDAQ 100 ETFs are available in India through Stockal.

How to invest in US-based ETFs from India?

In today’s technologically advanced world, it is very simple to make investments in the United States market from India and contribute to the story of global growth. You might wonder how to increase your portfolio’s exposure to the US market. Investing directly in US stocks is one option.

In this case, you purchase a certain company’s shares directly. But choosing which companies to invest in requires considerable knowledge of both the stock markets and the company’s finances. The use of ETFs or mutual funds which invest in US stocks is the alternative method of investing in the US stock markets. Diversification is a benefit offered both by mutual funds and ETFs. Under the RBI’s Liberalized Remittance Scheme, which permits you to transfer up to US $250,000 annually per person, you are permitted to do this as an Indian resident.

Here is how you can invest in a global ETF in India:

  • Purchase curated ETFs on the Stockal App
  • Purchase global ETF in India, which invests in the US stocks (For example, Motilal S&P 500 fund)

Or, alternatively:

  • Create a Demat Account via an Indian broker partnered with a foreign broker or foreign broker itself
  • Invest in ETFs traded on the US stock exchange

Also available are ETFs that invest in US markets which follow NASDAQ 100 ETFs in India, which you may also consider. Stockal will allow you and guide you through the entire process of investing in US Stocks/ETFs.

Wrapping up “what is an ETF?”

ETFs are flexible financial instruments that provide access to a wide range of stocks and other assets, like broad indexes or industrial sub-sector. ETFs can be used to create efficient, passively indexed portfolios because they frequently reflect an index of either a subclass or an asset class. ETFs trade all day long as stocks do, are more transparent and offer greater liquidity than some mutual funds.

An ideal portfolio for long-term objectives can be created by selecting the proper combination of ETFs. Markets and individual companies will experience ups and downs throughout time. However, a low-cost ETF portfolio could reduce volatility and assist you in achieving your financial objectives.

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