Exchange-traded funds: why is an ETF required in your mutual fund portfolio?

The reason why people invest in the market is to earn extra revenue, which will help them to take care of their expenses after retirement. Amongst the important aspects to remember about investing is that this action is a long-time commitment, and it will help you with long-term wealth accumulation. And, when it comes to investing, the income you earn from the investment plans is as good as the portfolio you construct. For the purpose of getting the portfolio right, you must get the asset i.e., equity, debt, and commodity allocation aligned with your objectives. For this, you need to spend sufficient time identifying and analysing each asset class and after that, determine the level of allocation. Numerous macro and micro factors affect the market sentiments, leading to sharp variation in performance. And staying up to date on all these factors, consistently, may not be easy for first-time investors. That’s where ETFs can be helpful.

What are ETFs?

A passive investment instrument, exchange-traded funds (ETF) are shared investment funds that track and replicate an index—which can invest in different asset classes such as equity, debt and gold. That way, ETFs operate in a manner like a mutual fund. Generally, they will track a particular index, sector, commodity, or other assets. However, unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can.

What are its key features?

  • Exchange-traded funds (ETF) are a collection of securities known for trading on an exchange just like a mutual fund does.
  • Share prices fluctuate all day as ETFs are bought and sold, making them different from mutual funds, which are known for trading once a day after the market closes.
  • They offer fewer broker commissions and low expense ratios than buying the stocks individually.
  • Another key feature of ETFs is that they can contain all types of investments, including bonds, stocks and commodities. Some even offer country-specific holdings, while others remain international.

Why are ETFs a must in a mutual fund portfolio?

Listed below are some of the aspects that make ETFs a valuable addition to a mutual fund portfolio:

  • Diversification can be achieved easily:

Through ETFs, an investor is exposed to multiple asset classes such as equities, bonds and gold. Each of these asset classes is known for behaving differently and has little to no co-relation in its performance. Also, diversifying your investments will help you cushion the negative performance of a single asset class and protects returns.

  • They have a wider spread:

Any investment you make is distributed among a wide set of securities that are a part of the underlying index in an ETF. For example, if you invest ₹ 500 in an ETF, your money will get distributed within all stocks in the index. This is advantageous compared to equities, wherein you need to buy a whole share of a single company.

  • They come with high liquidity:

They are known for trading daily on the exchange and do not have a lock-in period, meaning, you can enjoy the benefit of liquidity. It means that you are free to redeem your investments easily whenever you have a need.

  • They come with trading flexibility:

Exchange-traded funds also provide trading flexibility. In simple words, daily trading, as well as intraday trading, is possible with these funds during market hours. This provides you with an opportunity to better utilise trading opportunities that arise in the course of the day.

  • They are transparent:

The information about one’s ETFs is transparently available to investors all the time. Also, thanks to the passive approach to the investments, your returns match the benchmark index’s returns.

Simply put, the numerous benefits offered by an ETF, i.e., ranging from liquidity and flexibility to diversification and transparency, make it a valuable addition to a mutual fund portfolio. After determining things like your investment needs and financial goals, you can proceed to opt for an ETF.