1. Finance

How Do Exchange Traded Funds Work?

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ETF stands for Exchange Traded Fund. It is a Mutual Fund that includes a basket of securities that replicates the composition and performance of a particular market index. Nifty and Sensex are the most popular market indexes. Sectoral and market cap-based indexes are other options you can explore. Given this description, ETFs may sound like Index Funds. However, both works differently.

ETF are listed and traded on the stock exchange. This allows you to earn reasonable returns. ETFs pool investments from investors like you to invest them in tradeable monetary assets. It is a suitable investment pick if you wish to start your stock market journey and have minimal investment expertise. Here we decode how ETFs work and their various types.

ETF process

Characteristics of ETFs are a combination of both Mutual Funds and shares. They are traded like regular shares and listed on all major stock exchanges. You can buy and sell them as per your requirement during the trading hours. Change in ETF values depends on its underlying asset price. If the price of one or more underlying assets changes, it translates to a change in your ETF value.

The dividend earned through your investments depends on the performance of the ETF company you have invested with. The choice of active or passive investment is at your discretion. It is generally passively managed as it follows a particular market index. However, you can also choose to actively manage and make trade decisions by assessing the ongoing market standing.

What are the types of ETFs?

Based on the underlying asset, the fund can be classified into the following types:

  • Index ETF: They invest in a particular market index. They are the most common ETF considered. You only need to track a specific market index to determine investment returns.
  • Gold ETF: Here, the underlying asset of the fund is gold. You need not physically hold gold units under this scheme. The gold units are held on paper. It tries to replicate the price of 24-karat physical gold.
  • Liquid ETF: This ETF invests in government securities. They are ideal for short-term investment goals, making them highly liquidable. The fund offers reasonable returns and involves lower risk.
  • Bank ETF: Such ETFs invest in banking stocks listed on the stock exchanges. They are a more conventional investment option.
  • International ETF: These invest in foreign securities. It enables you to participate in the global securities market. You can also invest in foreign securities with your Mutual Funds. It is an incredible way to create a diverse portfolio and maximise returns. Stay alert with your market-linked investments, as markets are unpredictable.

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