How to Start Investing in ETFs: A Beginner's Guide

Exchange-Traded Funds (ETFs) have been drawing the interest of Indian investors who want to take advantage of diversified exposure to the financial markets. These instruments usually combine the features of mutual funds and stocks, offering exposure to different asset classes in a single investment. These instruments may seem to be complex to most first-time investors, but they are usually simple to understand, cost-effective and affordable. This article explains what ETFs are, their type, and how you may select one for yourself.

What are ETFs?

An ETF, or Exchange-Traded Fund, is a marketable security that usually tracks an index, sector, commodity, or asset. It is usually created to offer diversified exposure, including multiple securities within one fund. ETFs are usually bought and sold on stock exchanges like individual stocks and tend to reflect real-time prices throughout trading hours. The funds could be appealing to investors seeking a relatively low-cost and transparent means.

Explain Various Types of ETFs

ETFs exist in different forms, typically to meet different investment purposes and investment preferences. Here are the four common forms of ETFs:

• Equity ETFs: The equity ETFs typically track a stock index like the Nifty 50 or Sensex. They typically provide the investors with exposure to the market as a whole without selecting individual stocks. Equity ETFs are usually considered for long-term wealth generation and may reflect the performance of the overall market.

• Debt ETFs: Debt ETFs usually invest in treasury bills, corporate bonds, or government securities. These funds may be appropriate for investors seeking reduced market volatility. Debt ETFs are subject to interest rate risk; long-duration debt ETFs may show higher price volatility when rates fluctuate.

• Gold ETFs: Gold ETFs typically invest in physical gold and are usually secured by real reserves. Gold ETFs may allow investors to invest in gold in dematerialised form. Gold ETFs may be used as a hedge during inflation or currency devaluation, and the value of gold ETFs is usually aligned with gold prices.

• International ETFs: International ETFs usually invest in foreign equity markets or foreign indices. International ETFs may offer Indian investors international diversification. They may also offer exposure to international companies that are not listed on Indian exchanges.

Things to Remember When Selecting an ETF for Yourself

Before choosing an ETF, there are some crucial aspects to consider that typically make an impact on investments. Below are three primary considerations:

• Expense Ratio: The expense ratio usually reflects the annual fee charged by the fund manager. A lower expense ratio may lead to enhanced cost efficiency over time.

• Tracking Error: Tracking error is the difference between the ETF’s performance and the benchmark index. A lower tracking error often indicates improved index replication. It is often useful to monitor this metric before making a selection.

• Underlying Assets: Understand the components within the ETF. The fund's holdings should align with your investment goals and risk profile. Transparency of asset allocation may help in evaluating the ETF more effectively.

Conclusion

Starting your journey in ETF investing may feel overwhelming, but with structured information and cautious decision-making, it often becomes manageable. Understanding categories, liquidity, expense ratios, and tracking errors could help you make informed choices. For those beginning their ETF journey, platforms like Axis MF may offer structured tools and information to understand ETF structures more easily. As with any financial decision, careful evaluation usually leads to more confident outcomes.