How ETFs Build Wealth in the Long Term?

Are you looking for passive investment options? Do you want an investment that matches the returns of a market index? You may consider putting money in exchange-traded funds or ETFs. It’s similar to an index fund that tracks an index, commodity or sector. However, it is listed and traded on stock exchanges such as the BSE and the NSE. You may find investors focusing on index funds as actively managed large-cap mutual funds struggle to beat their benchmarks. Should you invest in ETFs to build wealth in the long term?

What are ETFs?

You have exchange-traded funds or ETFs as a basket of securities that track a particular index. It trades on stock exchanges such as the NSE and BSE. 

You may purchase ETFs just like stocks across the trading day. For example, you can invest in an ETF that tracks the Nifty 50 index. It helps as you get returns that match the market index over some time. 

You will find ETFs gaining popularity as fund managers of actively managed mutual fund schemes struggle to beat their benchmark over time. 

How ETFs build wealth in the long term?

You could diversify your core portfolio with ETFs to build wealth over some time. It may form around 60%-70% of your investment portfolio and provides stability with long-term capital appreciation. Moreover, ETFs are passive investments with a lower expense ratio as compared to actively managed equity funds. 

Studies have shown that ETFs which track a market index may beat actively managed mutual funds over some time. You have mutual fund managers struggling to generate alpha in recent times. 

It means fund managers cannot generate a higher return than the benchmark index whose performance they aim to beat while assuming a similar measure of risk. It helps if you stick to a low-cost investment such as ETFs that takes a long-term view of the stock market to attain your financial goals. 

You may invest in ETFs if you seek inflation-beating returns over some time. It replicates a market index and offers returns that match the index, such as the Nifty 50 or the BSE Sensex. Moreover, equity investments can outperform over the long run compared to bank fixed deposits that struggle to offer an inflation-beating return with interest rates falling in the economy. 

You have equity-linked ETFs taxed similarly as equity-oriented funds as they invest mainly in the equity class. The long-term capital gains or LTCG above Rs 1 lakh per financial year is taxed at 10%. You may invest in ETFs to earn tax-efficient returns compared to bank FDs if you fall in the higher income tax brackets. It helps you to accumulate wealth as you save on taxes over some time. 

You may invest in ETFs if you seek an efficient diversification of your portfolio. It is a suitable investment for first-time investors in the stock market. You could invest in ETFs through a systematic investment plan or SIP. It helps you invest fixed amounts of money periodically in a mutual fund scheme. However, it would help if you invest in ETFs only after determining your investment objectives and risk tolerance. 

How to choose the right ETF?

You must invest in an ETF with a lower expense ratio which is the cost of managing the mutual fund. It would help as ETFs are passively managed, and you must not incur a higher expense ratio if you want to increase take-home returns. 

You must invest in an ETF that efficiently replicates the market index it tracks. It helps if you checked the tracking error, which is the difference between the ETF return and those of the index. You must invest in an ETF with a low tracking error. 

You must invest in ETFs that trade on the stock exchange daily with high trading volumes. It ensures liquidity, and you can exit the investment when you require the money.

You can invest in ETFs to build your core portfolio and compound wealth over some time. It offers portfolio diversification at a lower cost with tax-efficient returns for higher-income tax brackets. Moreover, the ETF offers returns that match the market performance. In a nutshell, invest in ETFs if you prefer the passive investment strategy, which delivers return over the long run. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in