Are ETFs Tax-efficient?

5 mins read

An ETF (Exchange-Traded Fund) is a mutual fund that trades on a stock exchange. It functions similarly to a mutual fund in that it pools money from a variety of investors, has fund management, and has a Net Asset Value (NAV). On the other hand, an ETF has two defining qualities that distinguish it from other investment vehicles:

ETFs, like stocks, can be traded on a stock exchange like any other type of stock (in the secondary market)

It is a fund that is passively managed & tracks the performance of an index, and it has come out to be one of India’s most popular passive investment kinds.

Achieving performance in the Nifty 50 Index is monitored by the Nifty BeES, India’s first exchange-traded fund. As a result, to mirror the index’s results, the fund management purchases stocks from the Nifty 50 index.

Bonds and exchange-traded funds (ETFs) are traded on a stock exchange. Unlike stocks, investors can swap ETF units for cash, and the price of each ETF unit is determined by market demand & supply rather than the fund’s net asset value (NAV). Investors must first open a Demat account and a trading account with a brokerage firm to trade in ETFs.

Categories of ETFs

ETFs can be divided into four categories, which are as follows:

Stock indexes:

ETFs that track the performance of stock indexes or a set of stocks from a particular industry or business is known as equity exchange-traded funds (ETFs). The goal is to invest in equities that will outperform the index or industry in which they are benchmarked.

Gold exchange-traded funds (ETFs):

Investing in gold is considered to be an excellent strategy to preserve one’s wealth from currency fluctuations and economic downturns, among other things. However, there are significant downsides to investing in real gold, including the inability to resell the gold and the high cost. Gold ETFs invest in gold bullion, allowing investors to include gold in their portfolios without making a direct investment in real gold.

ETFs with international exposure:

Some exchange-traded funds (ETFs) are based on foreign stock indices. They provide investors with access to international markets and the opportunity to expand those countries’ economies.

Debt exchange-traded funds (ETFs):

These exchange-traded funds are primarily invested in fixed-income assets.

Why Must You Invest in Exchange Traded Funds (ETFs)?

An exchange-traded fund (ETF) is a terrific method to invest in stocks while diversifying your portfolio. When you invest in equity, you can only purchase a particular number of shares based on your money. As a result, selecting the most appropriate stocks is crucial. You obtain exposure to a broader range of assets when you invest in an exchange-traded fund that tracks a particular sector or asset class, which allows you to diversify and enhance your portfolio. The following are some benefits of investing in exchange-traded funds (ETFs):

ETFs, like bonds, are easily traded on stock exchanges and can be bought and sold at any time.

Because units are traded in the open market at prices controlled by investor mood, you will benefit if the industry or market that the ETF tracks has an upbeat outlook.

If you compare it to mutual fund units, which have to be redeemed at predetermined periods to benefit from the current NAV, you can purchase and sell units at any time during the day.

The cost ratio of an exchange-traded fund (ETF) is often lower than that of most traditional mutual funds (especially actively managed mutual funds).

To summarise, being knowledgeable about the investment options available and developing an investment strategy based on financial goals, time horizon & risk tolerance are the trademarks of a successful investor. Before you begin looking for an ETF to invest in, be sure that you have a policy in place and understand how ETFs work before you start looking. Because these funds are actively managed, they seek to approximate the index’s returns rather than outperform them. As a result, keep your objectives within appropriate bounds.

Index funds are subject to taxes

Because index funds are a kind of equity fund, they are taxed the same way any other equity fund plan would be. The dividends paid by an index fund are added to your total income and taxed at the rate applicable to your income tax bracket. The classical way of taxing dividends in the hands of investors is referred to as the dividend taxation method. Index funds are taxed differently depending on how long they have been held. When you redeem your units within one year of purchasing them, you will realise short-term capital gains on your investment. This type of gain is subject to taxation at a fixed rate of 15 per cent. Long-term capital gains are those that are realised when you sell your fund units after a holding period of one year and are defined as follows: These gains, up to a maximum of Rs 1 lakh per year, are now exempt from taxation. Taxation on gains above this threshold is at the rate of 10%, with no provision for indexation of the rate.