New to investing? Find out if ETF is a better option for you

Starting early to save and invest can help you in the long run. However, first-time investors need to have a proper understanding of the investment tools before jumping right into it. There are various options to choose from while investing, however, experts say that for new investors, who are not altogether familiar with the details of financial markets, ETFs are the best suited.

Why will ETFs be ideal for you?

Historically, in the US, the S&P 500 index has provided an average annual rate of 10 per cent return going all the way back 100 years to 2020. In India, the Nifty index has given over 12 per cent compounding over the last 25 years, “which is an incredibly powerful source of compound earnings to create wealth,” says Amit Dhakad, CEO and CTO of Market Pulse Technologies. Having said so, he adds, “investing in the stock market can be a formidable task, particularly for young people starting off – but they’ll be well served picking passive instruments like ETF’s rather than get entangled in the intricacies of the financial markets.”

Also, advantages like diversification, liquidity, professional management at a fraction of a cost as compared to other investment options make ETFs an ideal investment vehicle for young/new age investors.

Investing in ETFs is suggested because they invest in a number of stocks mimicking the performance of the underlying index by holding the securities in the same manner and combines the trading flexibility of a stock with the diversification and low costs of a mutual fund. Prateek Mehta, Co-Founder and CBO, Scripbox, says, “Since ETFs aim to replicate the underlying index, the cost of managing these mutual funds is low. Therefore, saving on the management cost.”

Experts believe plain vanilla ETFs such as the Nifty 50 ETF can be considered as a stepping stone into equity markets for new investors. Nitin Kabadi, Head- ETF Business, ICICI Prudential AMC, says, “An ETF can even be considered by someone who is not very familiar with the nitty-gritty of the financial markets, as ETFs have exposure to equities in a very simplified manner and at a very low cost.” He adds, “Given the age on their side, by starting to invest early on, young investors can benefit from the power of compounding over the years, thereby helping them to build a fairly sizable corpus over the years.”

How should you choose your investment?

The choice of instrument, be it ETFs or Mutual Funds, should not be made based only on the age of the investor. Mehta of Scripbox says, “The criterion for making that decision should be based instead on the objective and temperament of the investor. By design, an ETF or Index Fund will only provide returns in line with the benchmark index. So, from an investor’s perspective, if outperforming or underperforming a benchmark index is not a priority, these instruments can be looked at as an efficient vehicle for investments.”

Additionally, young investors must look for concentrating their investments in growth-oriented assets. That way one can take advantage of compounding higher rates of return from growth investments, instead of safer, interest-earning options.

Who are ETFs best suited for?

ETFs are suited for anyone looking to take exposure to equities in a simple manner with returns similar to that of the underlying index. Additionally, if you are among those investors who are not much aware of the markets in general, Kabadi of ICICI Prudential AMC says, “to start with investors could look at broad market index ETF such as Sensex ETF or Nifty ETF. This is because ETFs offer a diversified approach to investing as they have various securities and are better than buying into stocks directly.”

ETFs are also good for investors who do not have access to financial advisors or might not want to invest time and energy in looking for products that can potentially generate higher returns.

Mehta of Scripbox says, “An investor who has an inclination that a specific segment will do well but does not know enough to pick the winners in that segment, may find ETFs/ Index Funds a good option.”

For instance, as an investor, if you believe that the healthcare industry will do well over the long run but are not sure which companies within the segment may do well, it could be a good idea to invest in a fund that tracks the healthcare index. That said, Mehta adds, “sectoral bets are usually for people who understand the sector deeply and can figure out ways to benefit from the vicissitudes of that specific industry.”

ETFs traditionally have been a mainstay of institutional investors but over the past 5 months, the total number of investors in the segment has doubled, indicating a rising interest among retail investors.