Every Fund or asset class serves a specific purpose in your investment portfolio. So does Exchange Traded Funds or ETFs. ETFs are a kind of passive funds. When adding ETFs to your investment portfolio, you must understand what purpose they serve. 

Read our blog on what are passive funds here. This blog will guide you through the same.

When you are looking to invest in exchange-traded funds, consider these parameters:

• What is Your Investment Goal?

This is one of the important questions you need to answer. You must have a clear purpose before including ETFs in your portfolio. Whether it's for retirement or funding your child’s education, having an objective will help you choose the right ETF. For example, should you choose a simple index-based ETF or a more specific one like a large cap index, small cap, or sector-based ETF?

• What is Your Investment Horizon?

Before you begin investing in passive funds or exchange-traded funds, be clear about your investment horizon. Although it depends on your financial goals and risk appetite, the longer you stay invested, the better your chances are to build wealth.

• What is Your Risk Tolerance?

Although passive funds do carry some risk as they are market-linked, how comfortable are you with market fluctuations? If you can tolerate the market’s ups and downs, you have the opportunity to grow with exchange-traded funds.

Types of ETFs

You might find these types of exchange-traded funds (ETFs) commonly chosen by investors:

• Index ETFs: Those who track a particular index are known as index ETFs.
   
• Fixed Income ETFs: These funds are designed to provide exposure to a broad range of debt investments including bonds.
   
• Commodity ETFs: These funds track the price of specific commodities, like gold, oil, or corn. They are known as commodity exchange-traded funds (ETFs).
   
• Sector and Industry ETFs: These focus on specific sectors or industries, like technology, healthcare, or energy. By investing in these, you may target a particular area of the economy that you believe could perform.
   
• International ETFs: These funds offer exposure to markets outside of your home country, allowing you to diversify globally and potentially capture growth in emerging markets.

Every investor has a different purpose for investing, whether he invests in active funds or passive funds. You need to have a purpose to invest, and with that aim in mind, you could consider investing in ETFs. Your investment horizon, your investment aim, and your risk appetite — consider these three things before you add ETFs or any other fund, such as index funds or fund of funds, to your portfolio.
 

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