Trading of units
The buying and selling of ETF units is done through a demat account, for which investors have to pay broker commissions and other charges. Investing in and redemption of MF units, on the other hand, can be done through an investment advisor. One should choose an ETF based on its trading volume and liquidity. The higher the trading volume, the greater the liquidity usually. Choose ETFs that have shown good historical returns for reasonable fees check the ETFs offered by various fund houses and compare them to pick the best. It might be cheaper to buy an ETF compared to an MF as transaction costs are lower.
ETFs and MFs are taxed similarly as they are both equity investments. There is a 10% capital gains tax on short-term investments (less than one year) and no tax on long-term investments (over a year). However, ETFs are subject to other taxes such as STT and service tax since they are traded on stock markets.
The price of an index ETF fluctuates throughout the trading day, making it more volatile than a regular index MF.
However, if you invest in an index ETF for the long term, price volatility is unlikely to have a substantial impact on your investment.
Like MFs, ETFs also provide a diversified route to invest in stocks (be it a specific sector, theme, or the broader market as a whole), bonds and commodities. So, instead of investing in a particular set of portfolio stocks, choose the ETF route to diversify at a lower cost.
Note that ETFs, like stocks, can be easily bought or sold at any point in the stock market but each time you trade you must pay brokerage. So, it is important to know the brokerage and other transaction costs.
In ETFs, one can either choose the dividend (only payout) or growth option; there is no automatic dividend reinvestment option. Dividends are paid to the investor, who needs to reinvest them, resulting in reinvestment risk and, possibly, higher costs. There are some common thresholds for ETFs. One has to choose an ETF with an asset size above the threshold and minimal tracking error to cut risk.
Investors looking for short-to-medium term returns (who usually have greater risk-taking ability, and the time to monitor prices) prefer ETFs. Since systematic investment plans (SIPs) are not available in ETFs, the time of entering the market is crucial.
The writer is CEO and Founder, Right Horizons