Looking to invest in ETFs? 5 Tips for ETF investors

An exchange-traded fund (ETF) is comprised of different securities that trade on an exchange, providing investors with a choice for diversification. An ETF generally tracks a stock index, commodity, bonds, or a group of assets and its value is based on the net asset values of the underlying stocks that it represents.

One of the major points of difference between a mutual fund and ETF is that unlike mutual funds share prices of ETFs fluctuate all day as they are bought and sold on an exchange. Over time, ETFs have become very popular among small and large investors as they provide several benefits to investors over other investment options like Mutual Funds.

Benefits of ETFs

• Buy/sell flexibility: Just like stocks, ETFs are traded on exchanges, which means that one can buy and sell during trading hours.
• Returns from capital appreciation and income: Depending on the type of product and the benchmark being tracked by ETF, investors can earn returns through capital appreciation and/or distributions.
• Low Cost – The operating cost of ETFs are less as compared to other investment options like Mutual Funds. The operating costs of a typical mutual fund include portfolio management fees, custody costs, administrative expenses, marketing expenses etc. In the case of ETFs, many costs are being passed on to brokerage firms which makes them less costly than Mutual Funds. Due to the low-cost feature of ETFs many investors like to invest in ETFs than in Mutual Funds.
• Portfolio Diversification- As ETFs are traded on almost every major asset class, commodity, and currency and it help investor to gain easy exposure to a specific desired market segment. By diversifying the portfolio, an investor can invest in a variety of different asset classes at one point of time which helps the investor to manage the overall risk of its portfolio.

Like any other investment option, ETFs too has advantages and disadvantages. An investor needs to understand all the aspects of the ETFs before taking an investment decision. We have come up with few suggestions which investors should take a look on, before investing in ETFs.

1. Be aware of the investments included in an ETF

As already mentioned, ETF’s includes different investments so that the risk can be distributed. However, one must not think that ETFs can completely save someone from underlying fluctuations and risks. The potential of the change in ETFs prices will mainly depend on the scope of the fund, hence investors should be aware whether an ETF is tracking a broad market index or it is tracking a specific industry or sector.

For example, investors must know that some ETFs comprises investments such as small companies, emerging markets or commodities that may be harder to sell in certain circumstances, this increases the risks for investors.

2. Taking advantage of seasonal trends

ETFs generally replicate the performance of an underlying assets, hence if an asset which is being tracked by an ETF is gaining on an exchange due to some seasonal trend, it will surely benefit the inventors of ETF as well.

For example, if gold starts gaining on exchange due to a seasonal trend, there is a high chance that an ETF which is tracking Gold as its underlying commodity will also gain momentum.

3. Be aware of errors and flaws of ETFs

It is to be noted that due to fees, taxes, and other factors, ETF prices might not exactly replicate the price of the index or investment they are designed to track.

In addition to this, Investors can also witness Price errors which generally occurs when offer price quoted by a broker is significantly above the NAV per unit of the underlying assets, creating a risk that investors might pay far more for an ETF than it's worth. In these cases, it is better to buy or sell ETFs when the market for the underlying asset is open as this will reduce price discrepancies between the ETF and the price of the shares that it holds.

ETF is consist of various classes of assets of which investors have not control while selecting. It means that an investor cannot remove a stock from its ETF even he/she wants to and likewise, it cannot select a particular stock to add in the ETF.

4. Be aware of risks

There are several risks that are involved with ETFs. These include:

· Currency risk- In cases, where an ETF is tracking overseas assets, changes in the value of currency may also affect the value of the investments;

· International taxes - foreign taxes are generally implied on ETFs located in another country;

• Market liquidity- ETFs offering exposure to investments such as small companies, emerging markets or commodities that may be harder to sell in certain circumstances.

In order to trade better with ETFs one must be aware of the above-mentioned risks so that an informed decision can be made.

5. Use hedging to protect from losses
   
   

In order to protect the losses from ETFs which have been acquired as the result of an inheritance, an investor can opt for put options to offset any expecting losses. This form of hedging helps investors to safeguard themselves from expected losses.

The above-mentioned tips can help investors to improve their decisions while they are buying and selling ETFs on exchange.

Key takeaways:

• Be aware of the investments included in an ETF
• Taking advantage of Seasonal Trends
• Be aware of errors and flaws of ETFs
• Be aware of risks
• Use hedging to protect from losses