ETF or Exchange Traded Fund is a pooled investment that works like a mutual fund where an investor can enjoy the benefits of a stock investor. ETFs are less volatile during situations that affect the market, such as inflation and the market surge, meaning the investments do not swing in value as much. The best-performing ETFs will have low expense ratios.
Although ETFs came into existence in the 1990s in the USA, they started exploding in 2004. Since then, they have evolved around the world. Let alone from October 2019-2020, the ETFs market in the overall mutual fund industry grew from 6% to 7%. And the equity and debt ETFs have risen from 39% in 2014 to 93% in 2020.
The investor can buy or sell the ETFs on a stock exchange just like stocks and can avail themselves of the features like benefiting from dividend payments, reinvestments, and other benefits.
Five Factors to Select the Best ETF
Market Risk
ETFs are an underlying investment asset. By this, we mean that ETFs also face market risks similar to that of mutual funds or closed-end funds.
In the long run, ETFs may fluctuate values based on several factors. Like specific market indexes are highly volatile, a market index of the S&P 500 is less volatile for ETFs. As an investor, one must dig deep and understand the types and risks associated with these types before making any investment decision.
Portfolio Risks
Diversification of an investment portfolio is always considered safe. Similarly, ETFs can be a safer investment. Even though ETFs are safe, there are some risks associated with them. Out of all, considering the facts like political and liquidity risks, the geographical area of a fund plays a significant role in the EFT. Investors must look at the origin of the fund before adding it to the ETF portfolio.
Tax risk
One of the elevated advantages of an EFT is tax efficiency. Investors should pay taxes based on the type of ETF fund they hold. ETFs like U.S. Stock Equity Index ETF comes with grand tax efficiency while most other EFT types do not. Hence, investors need to understand the importance of tax on ETF funds. Or else this could lead to a huge tax bill.
Liquidity
The liquidity of the underlying funds determines the liquidity of an EFT. The fund’s liquidity will be high when there is a smaller bid, and the liquidity will be less when there is a higher bid. The ETF’s liquidity can be superficial. However, The great creditors and the investors will look at a liquidity ratio of 2 to 3. All the related information about a particular stock can be managed using a stock tracker app.
Trading Risks
Unlike mutual funds, investors cannot buy EFTs with zero transactions. Like an actual stock, EFTs will have a spread that can vary from a dollar to many dollars. These spreads can change from time to time. It might be small one day and can become wide the other day. The trading risks and the liquidity of an ETF go hand-in-hand. The investor must go through the liquidity and trading risks to maintain successful investing relations.
