Why should retail investors go for Exchange Traded Funds (ETF's) rather than Direct Equity?

Why should retail investors go for exchange traded funds (ETF's) rather than Direct Equity?

Direct Equity investment has the potential to deliver much higher returns than fixed income products but for retail investors, it is not easy to handle the risk.

> Undoubtedly, Equity investment can provide much higher return than fixed-income instruments. But equities are subject to market risk & may become highly volatile at times when the economic outlook of the country becomes uncertain like the one we witnessed last year when the Covid pandemic broke out in the country. 

> To handle the risk involved in direct equity investment requires expertise, which most retail investors lack. So financial planners mainly advise retail investors to go through the ETF route to get a higher return at lower risk.

Here are key advantages of ETF over Direct Equity Investments :

1. Risk : An ETF is a type of mutual fund that invests in Equities of an Underlying Index in the same proportion as that of the underlying index. As ETFs track a particular index there is no scope for fund managers' discretion, which sometimes may go wrong. So by investing in ETFs retail investors can expect the return of an index at much lower risk than that of direct equity investment.

2. Diversification : To minimise the risk of Equity investment you need to have a portfolio of stocks across sectors so that if one stock or sector does not perform then returns from other stocks will offset the losses of non-performing sectors/stocks & overall you get a decent return. But to create a proper diversified portfolio one needs to have the understanding of different sectors & stocks & retail investors mainly lack this knowledge.

But by going through the ETF route, you get a readymade portfolio composed of the same stocks in the same ratio as its benchmark index has. Hence the risk gets minimised.

3. Capital Requirement : In case of direct equity, an investor needs to invest a sizable corpus to create a portfolio of stocks that can tackle market risk. But in ETFs you can start with as low as ₹ 5,000 investment & can own a portfolio that is equally efficient as that of the underlying index in handling risk.

4. Taxation : Indirect equity investment, an investor is liable to pay capital gain tax each time he sells stocks depending on period of investment & amount of gain/loss.

However, in the case of an ETF investors are required to pay capital gain tax only when they sell units & not on every transactions made by the fund to realign the portfolio with the benchmark index.

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