In the times of YOLO, POV, FOMO, LOL, and many more, one more new-age abbreviation deserves to get your attention and a place in your everyday life. Short for an Exchange Traded Fund, an ETF is one of the relatively newer investment options in the market. Is it worth investing in an ETF in India or not is something that may have crossed your mind and something that we are going to address today.
But before we dive into ETFs and their characteristics, let’s first understand why it is crucial to invest your money anyway.
Savings and investments – why are they such a big deal?
The short answer is wealth creation. Your salary can only get you so far. The rest of the gap can be covered with disciplined savings and investments. By investing your money, you allow it to multiply and grow over time. You also save it from getting robbed by inflation, which can eventually render your savings less valuable. However, being a young, independent individual translates to a hectic schedule in today’s times. This probably means you may not always have the time to invest in options like direct equities, where you have to build your portfolio yourself, time the market, and devise exit strategies. This is where ETFs come in as the ideal investment option.
What are ETFs?
ETFs are like a big hamper of different securities, including stocks, bonds, and commodities that tracks an underlying index. This means that an ETF follows a benchmark index and tries to replicate its performance. An ETF in India is a combination of a stock and a mutual fund. It is traded on the stock exchanges like stocks. It is also highly liquid like shares and can be bought and sold throughout the day. This means you can buy and sell units of ETFs from the stock market anytime you want.
Further, it pools money from different investors, as in the case of mutual funds. The fund manager invests your money further, and the profits are given back to you as returns. ETFs also have a Net Asset Value (NAV) like mutual funds.
Some ETF examples in India include the Nippon ETF Nifty BeES, LIC MF ETF – CNX Nifty 50, and ICICI Prudential Nifty ETF, among several others. [SS1] There are also different types of ETFs like equity ETFs, gold ETFs, bond ETFs, and international ETFs. You can invest in any of these based on your financial goals.
The past, present, and future of ETFs
The Nifty Benchmark Exchange-Traded Scheme (Nifty BeES) was the first-ever ETF in India introduced in 2001. It was offered by the Benchmark Mutual Fund. This was followed by Liquid BeES in 2004, the first debt ETF in the country. However, ETFs really thrived after the economic crisis of 2008 that engulfed the world. ETFs presented investors with comparatively more security and thus appealed to beginners and experts alike.
According to AMFI, asset under management (AUM) for ETFs grew by 1345.77% between 2015 and 2020 in the country1. There was a further increase of 136% in ETF AUM between 2020 and 2022, stated a survey report by Morningstar India2. These rising numbers are testament to the fact that ETFs are attracting many investors and are indeed here to stay.
Here are some ETF benefits that can help you make the decision to invest in them:
ETFs offer a lot of convenience: They are passively managed by a fund manager, so the burden to manage your investment and time the market is off you.
ETFs are highly liquid: ETFs can be bought and sold at any time of the day. They are ideal if you are in a financial emergency and need immediate funds.
ETFs can help you lower portfolio risk: You can take care of your portfolio’s diversification needs by adding ETFs. ETFs are great at diversification. However, keep in mind that they are still susceptible to market volatility.
ETFs may have a lower expense ratio: ETFs can be a cost-effective investment option with lower expense ratios than most mutual funds.
To understand ETF taxation, you first need to know that there are two types of incomes that you can earn from investing in an ETF in India – a dividend and a capital gain. Here’s how each of these is taxed:
Dividends: Any dividend earned is added to your taxable income for the year and taxed per the tax slab you fall into.
Capital gains: Capital gains are taxed according to the type and duration of the fund. Equity ETFs are levied long term capital gains (LTCG) tax on earnings in excess of Rs. 1 lakh per annum at the rate of 10% for funds held for longer than a year. Short term capital gains (STCG) on equity ETFs are taxed at 15% for funds held for a year or less.
All other ETFs like debt, gold, etc., are taxed like debt funds. LTCG for funds held for longer than three years are taxed at 20% with indexation benefits. STCG tax is levied on profits from funds held for three years or less. Like dividends, these earnings are added to your taxable income for the year and taxed accordingly.
To sum it up
With the increasing popularity of ETFs, this can be a great time to take advantage of the many ETF benefits and create wealth for your future goals. Investing in an ETF in India can be suitable for all types of investors. However, beginners can particularly benefit from them because of the added convenience and high liquidity. So, what are you waiting for?
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