Why is demat account necessary for investing in ETFs?


Investing in stock or mutual funds should be looked upon as a long-term goal.  It is almost impossible to become rich overnight. You cannot expect mutual fund schemes like equity funds to show results over the short term. Due to market volatility, an equity scheme’s performance fluctuates from time to time. Instead of fearing that you will lose money, investors should act and instead of panicking buy more units when the NAVs are low.

There are some mutual funds like exchange traded funds that function just like company stocks. Investors who usually invest in mutual funds might find ETF investing confusing. On the other hand, those who are stock market investors, they might find ETF investing. If you too are new to mutual fund investing or want to understand what ETFs are and what are the mandates of ETF investing, continue reading.

What are exchange traded funds?

Exchange traded funds, commonly referred to as ETFs are open ended mutual fund schemes which aim at generating capital appreciation by tracking the performance of an index, commodity, sector with minimal tracking error. Market regulator SEBI defines exchange traded funds as open-ended schemes which must invest a minimum of 95 percent of their total assets in the indices / commodities / underlying benchmarks which they replicate for income generation. ETFs are passively managed funds carrying a low expense ratio since the fund manager has very little role to play in the scheme’s performance.

Benefits of investing in exchange traded funds

Several people do not invest in mutual funds because they feel that the performance of a scheme depends on fund managers who buy / sell securities in quantum with the scheme’s asset allocation and investment strategy. Some people do not like investing in mutual funds because mutual funds diversify their portfolio by investing in certain sectors/asset classes/fixed income securities/economies. A mutual fund manager has to invest a particular portion of its assets even when that commodity or asset class is not performing at the moment. This type of investing is not preferred by certain investors who argue that they do not want to invest their money in a sector / industry that is on the decline. But in ETF, the scheme aims to outperform its underlying index by majorly investing in that index. Since there is no active involvement of the fund manager, the performance of an ETF doesn’t depend at the mercy of the fund manager but entirely depends on how that particular asset or commodity performs overall.

Can you invest in ETFs without a demat account?

ETF units are bought and sold at the stock exchange like any other company shares. However, when you buy company shares using your trading account, the number of shares that you receive are preserved in the demat account. Without demat account one cannot buy or sell stocks. While you can buy / sell units of other mutual fund schemes through your mutual fund account, investors need a demat account to buy and hold their ETF units. When you purchase ETF units, they are stored in the demat account. This is why it is mandatory to have a demat account to invest in ETFs.

Exchange traded funds offer liquidity to your investment portfolio. Some equity schemes like ELSS come with a predetermined lock in period of three years. To ensure that you have enough resources in case of an exigency, investors can invest in ETFs. One can sell their ETF units during market hours and hope the amount to be transferred to their registered savings account.

ETFs are a high-risk investment requiring investors to carry a high-risk appetite. If you are new to mutual fund investing it is advisable to talk to your financial advisor before investing.

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