What are exchange-traded funds?

Exchange traded funds or ETFs are index tracking funds. They are listed on the stock exchange and can be traded as individual shares. An ETF tracks the value of a stock index or the market as a whole. They are liquid funds and can easily be bought or sold exactly like the shares of an individual company during the trading day. ETFS offers a wide range of investment options. They can help investors create a diversified portfolio that is easy to track.

Most ETFs represent a portfolio of stocks designed to track the performance of market indices. Since indices are constantly weeding out the under performers and picking up the good ones, a trader is always investing in the top performers the market has to offer. Therefore, your index-tracking ETF offers returns according to general market trends.

The advantages of ETFs over mutual funds

Investments in ETFs are considered better investment options than mutual funds. Even a good mutual fund can stop performing as well as the market for a period of time. There are many reasons for this:

1. There are hundreds of mutual funds in the financial market. An ordinary investor may find it difficult to analyze and compare the performance of these funds. Also, all funds may not have a competent fund manager.

2. Mutual funds generally have high fees and overheads. Cumulatively, they negatively influence the fund’s actual performance. Yields drop dramatically over time.

3. The portfolio manager of a mutual fund that shows good performance may leave it for better opportunities elsewhere. The successor may not be as good as its predecessor.

4. Mutual funds are actively managed. A fund that delivers 30% in the first year may not perform well the next year. It is quite possible that the company will boldly tell you how it delivered 30% the previous year, but it will not actually reveal that its actual return was much lower when losses are taken into account. Even star players in mutual funds can go down in a matter of two years. Remember the excellent performance of dot.com stocks and the funds that invested heavily in them.

5. Mutual funds have a history of poor performance over the long term, except for short periods when only 50% of them could beat the market.

Unlike mutual funds, the tracking index for exchange-traded funds works like the market. It shows a gradual but positive general uptrend. ETFs don’t employ expensive, high-profile managers like portfolio managers in mutual funds. They don’t incur maintenance costs, paperwork fees, or operate from fancy offices. An index tracking ETF is in fact just an instrument that tracks a market index like the NASDAQ 100 or the S&P 500. Of course, you can’t expect instant dream gains, but you don’t have to suffer big losses either. The reason for this is that an ETF market goes up historically. Plus, you can buy an index trading ETF at a fraction of the cost of a mutual fund and yet expect a much higher return.

The arguments for and against ETFs versus mutual funds boil down to whether you want a low probability of a surprising return or a high probability of a good return. This can be explained with an example:

Suppose you invest $ 10,000 with a popular market-tracking index ETF with a historical return of 10%. Your total return over a decade should be $ 25,937. Suppose you invest the same amount in a mutual fund during the same period. Most likely, only one or two in ten, or about 15%, will outperform the market index fund. This means that out of ten possible investment returns, only one or two would exceed the return offered by exchange-traded funds. Obviously, the odds are 5 to 1. There is also the possibility that your investment in a mutual fund will end in losses. Even if you make a profit, they may be more than wiped out by your high fees and overhead.