Marketlive.in brings in Stock Market tutorials explaining the Exchange Traded Funds(ETF). The tutorial explains in simple terms how ETFs work, what are the costs involved in it and how one can invest in an ETF.
What is an ETF ?
ETF stands for Exchange Traded Fund . ETF is a fund that is traded in a Stock Market, exactly like a stock/share. People can buy and sell ETFs similar to trading in stocks in a stock market.
Basically, ETF is a fund that can track an underlying instrument. The underlying instruments could be commodities (like Gold, Oil etc.), stocks, stock market indices, currencies, bonds and so on. The fund owns these underlying assets. This ownership is thus shared among the buyers of the ETF. Similar to a stock, the ETF holders are entitled for a share of profit arising out of these underlying assets.
What is the difference between ETF and Mutual Fund ? ?
Similar to an ETF, a mutual fund is also a fund managed by a fund agency. A mutual fund will also have underlying assets such as the stocks, bonds and so on.
However a mutual fund will not be traded in the Stock market on a daily basis. An ETF will be traded daily in the stock market just like any other stock. So the price variations of one unit of the ETF might be significant as it gets traded in the exchange. For a mutual fund, the Net Asset Value (NAV) is calculated only at the end of the day. The NAV for a mutual fund will vary depending on the variations in the prices of the underlying assets during that day.
Some of the mutual funds impose a minimum amount to be invested in the fund. However there is no such limitation when it comes to an ETF. The minimum amount you have to invest is the amount required for buying a single unit of the ETF in the stock market.
Also Mutual funds might impose Entry and Exit loads. Most of the ETFs do not have such loads. However in case of an ETF, you will be required to pay the Brokerage amount to your Stock broker, similar to what you pay when you purchase stocks.
How to buy and sell ETF?
ETFs can be bought and sold very similar to the stocks that are traded in the Stock market. One can place a buy order for buying ETF units using the same terminal that is used for trading stocks. Very similar to the stocks, buying ETF units will require you to pay the brokerage to your stock broker.
What is the cost involved in ETF ?
Every ETF will have certain costs associated with it. These include the Management Expense Ratio, Operational Expenses and Brokerage amount. Management Expense Ratio is explained in detail in the below section. Operational expense is the expense that the fund incurs for various operational activities such as compliance with the regulation bodies, fees paid to the board of governors of the fund etc. Brokerage is the amount that you pay as commission to your stock broker when you buy or sell an ETF unit in the stock market.
What is the Expense ratio in ETF ?
Expense ratio is also sometimes called as Management expense ratio. For an ETF, it is the portion of the fund’s average net assets that will be paid out of the fund each year to cover the costs of managing the fund. It includes the management fee paid to the Fund manager.
The expense ratio is the major component which will vary the price of a single unit of ETF among various funds, even if the underlying assets of all these funds are the same. For example in case of Gold ETFs, although all the funds represent the same underlying asset (roughly equivalent to 1gm of Gold), the price of each fund unit will vary, depending on the expense ratio of that particular fund.