ETF is the acronym of Exchange Traded Fund, a relatively new phenomenon which is gaining popularity rapidly.

An ETF holds assets

ETFs are like Mutual Funds because they hold underlying assets like stocks, debt, commodities future contracts etc. If you are new to the concept of ETFs, think of it as a Mutual Fund , and build your understanding from thereon. An example of an ETF is the SBI Gold ETF, which holds physical gold as its underlying asset. As a private investor, it is easier to invest in a gold ETF than to buy physical gold, hence a powerful advantage.

ETFs are passive investments

Compared to Unit Trusts, ETFs invest in assets which are pre-determined by the fund mandate, and that is it. The fund manager will not actively manage the fund, hence it is more of a passive investment. For example, some ETFs track the S&P 500, this ETF will provide you the same returns as the S&P 500 while you do not have to buy each stock individually, the fund manager does it for you. But since the fund manager buys exactly S&P 500 stocks in the same proportion as the index, it is not actively managed to try to beat the index.

ETFs charge you for their expenses

Like Unit Trusts, running a fund is costly. ETF fund manager therefore charge a fee to the investors which is expressed as a percentage called: “Expense Ratio”. The lower the expense ratio, the less the fund manager charges the investor. You should try to compare expense ratios between different ETFs, as that will tell you how much you have to pay in fees. All Unit Trusts do this too, so in this respect ETFs are like Unit Trusts.

ETFs do not need a minimum investment

Unit Trusts have a minimum investment amount, and you need to invest at least that much in order to get in the fund. On the other hand, ETFs don’t have any such minimum investment requirement, and you can buy just one unit of an ETF, if that’s all you want.

ETFs trade all day long on a stock exchange

The above points discussed the similarities between a Unit Trust and an ETF. In this section, we discuss a key aspect in which ETFs are different from Unit Trusts.

ETFs trade on a stock exchange and can be bought and sold any time during a trading day. If you have a brokerage account and buy stocks through that – you can buy ETFs the same way. On the other hand, you can’t trade a Unit Trust using your brokerage account. In this respect, an ETF is similar to a stock.

Brokerage fees on ETFs and stocks are the same

Since you can buy ETFs like you buy stocks, the brokerage you pay on both are identical. The commission that your broker charges for stocks is the same as would be applicable for buying ETFs.

No front-end load is charged by ETFs

A lot of Unit Trusts charge a front-end load, which is nothing but fees that you pay when you buy the fund. ETFs don’t charge any front-end loads to investors.

You can short an ETF

You can short an ETF if you wanted to. This can’t be done with Unit Trusts. Shorting an ETF means that you expect the ETF price to go down, hence you want to profit from the price decrease. You borrow the ETF from somebody, sell it on the market and buy it back later when the price is lower. You make the difference on the sale and buy price.

ETFs can be traded on a margin

Like stocks – ETFs can be traded on a margin. This is particularly interesting, since ETFs are less risky than stocks. Indeed, the mere fact that most ETFs invest in a basket of assets means that you enjoy the diversification effect. When using leverage, you will increase your risk position, but also the potential rewards.

Conclusion

ETFs are like Unit Trusts but offer a lot more flexibility than them and less costs.