Myths about Exchange Traded Funds (ETFs)

1) ETFs Are Similar to Individual Stocks:

Like MFs, ETF consist of an underlying portfolio of securities that's designed to follow a specific index or investment strategy. Hence, they are as diversified as various mutual funds.

2) ETFs Only Invest in Equity:

Since they are listed on the exchange, the general belief is that ETF only consists of equity asset class. Globally, ETFs are available across asset classes – equity, debt, commodities, real estate and so on. In fact, over the past couple of years, India has also seen the emergence of Gold ETFs.

3) All ETFs Are Index Funds:

ETF started as a fund which used to track indices and hence they were branded as index funds that are listed. However, ETFs have progressed rapidly and are no longer associated only with passive index funds. Globally, we have seen the launch of actively-managed ETFs. In India, also we recently saw the emergence of fundamentally-weighted ETFs on Nifty, which busts the myth that ETFs are index funds and can only give an investor Index returns.

3) ETFs Are Riskier Than Mutual Funds:

ETFs, like mutual funds, come in a variety of shapes and sizes. The level of risk in an ETF or mutual fund is often determined by the portfolio holdings within the fund. Some indexes, industry sectors, or markets will be more risky or volatile than others.

4) ETFs Are For Short-Term Investors:

Since ETFs are listed on the ex-change, serious long-term investors feel that it is not suited to meet their goals and is only fit for traders and short-term investors. The truth is that ETFs are effective portfolio-building tools for all types of investors. While ETFs are often used by active investors as trading vehicles, they can be effectively used by buy-and-hold or long-term investors as well. Whereas one investor may purchase a particular ETF to hedge, another may purchase the same ETF with a completely different strategy, perhaps to grow capital. The unique product design of ETFs allows investors with both similar and dissimilar investment objectives to own the same fund and still accomplish their goal.

5) Individual Stocks & MFs Are Better Than ETFs:

Like mutual funds and stocks, ETFs track a variety of asset classes across markets. In any given year, some stocks and funds may actually outperform certain ETFs, whereas during other time periods they'll under perform. The economy, inflation, interest rates, and market conditions are a few factors that will impact performance.

6) ETFs More Expensive Than MFs:

The buying and selling of ETF happens through the exchange and hence needs to be done through a brokerage house and to pay a brokerage commission, thus making it expensive compared to MFs. We have seen big drop in the brokerage rates for buying and selling through the exchange. The Total expense ratio of ETF is far lower than the mutual funds, negating the impact of brokerage commission completely and still keeping it very cost effective. ETFs do not carry any exit load or back-end redemption charges for selling their funds before a restricted time period. Any fair cost analysis between ETFs and mutual funds should look at the entire spectrum of expenses — not just the transaction fee to acquire the fund.