Equity investments are subject to market risks, especially in short term. However, compared to fixed-income instruments, equities provide higher returns in long term.
There are many ways of investments in equities – like direct equities, Mutual Funds (MFs), Exchange Traded Funds (ETFs) etc.
Here are the advantages of ETF over the other ways of equity investments:
Out of the above three, investments in direct equities are considered most risky, as an investor may lose the entire capital invested if the company goes bankrupt. So, an investor should have enough knowledge, experience, time and interest to study markets and stocks before selecting a stock to invest.
An ETF on the other hand is a type of MF that invests in equities in the same proportion as that of its benchmark index. These funds are managed by professional fund managers and hence investors needn’t have adequate knowledge or time to study the stocks.
Diversification is essential to minimise risks of equity investments as the entire capital invested won’t be at risk. Even if a company gets bankrupt, other companies in the diversified portfolio would offset some of the loss.
So, in case of direct equity, an investor has to choose a number of stocks to minimise risks.
In case of an ETF, however, an investor gets a readymade portfolio composed of the same stocks in the same ratio as its benchmark index has.
In case of direct equity, an investor has to buy at least one share each of a number of companies, which require a relatively large investment amount as good stocks are always transacted at a high price.
On the other hand, an investor may invest a small amount in an ETF to purchase units or a fraction of units having the same composition as the portfolio of the fund.
An investor is liable to pay capital gain tax each time he/she sells/redeems stock(s) depending on period of investment and amount of gain/loss.
On the other hand an ETF investor would pay capital gain tax only when he/she sells/redeems the units and not on every transactions made by the fund manager(s) to realign the portfolio with the benchmark index.