What are the limits of an ETF?

A mutual fund is a professionally managed company that collects money from many investors and invests it in securities such as stocks, bonds and short-term debt, equity or bond funds and money market funds.

Mutual funds are a good investment for investors looking to diversify their portfolio. Instead of betting everything on one company or sector, a mutual fund invests in different stocks to try to minimize portfolio risk.

The term is typically used in the US, Canada and India, while similar structures around the world include the SICAV in Europe and the open-ended investment firm in the UK.

What are the limits of an ETF?

ETFs are passive investment instruments that track an underlying index and trade on the stock exchange just like stocks. But ETFs must be bought and sold by the exchange through a broker. You must have a demat account to trade ETFs and you must pay commissions to the broker for each transaction. If you’re tempted to invest in ETFs to capitalize on their real-time trading, the cost of commission can reduce your returns over time.

Second, ETFs do not offer the advantage of the average rupee costs that is available in mutual funds through SIP. If you want to make regular investments in ETFs, you will also have to bear the cost of the commission on each transaction. ETFs do not offer features such as growth and the dividend option where investors can choose an option that best suits their financial goals. For example, ETFs cannot meet the requirement of a retiree seeking a regular income or someone seeking dividend payments on a regular basis.

Some ETFs are niche or industry specific and are poorly traded. Investors may face a wide bid/amma spread (the deviation of the ETF’s current price from its NAV) when transacting in ETFs. While ETFs offer intraday trading opportunities that can be tempting in the short term, they could be detrimental to a long-term financial plan.

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