ETFs Explained
What is it?
An ETF (Exchange-Traded Fund) is a type of mutual fund that trades on a stock exchange throughout the day, just like a stock. Most ETFs are designed to track a specific market index, sector, or commodity, and their price moves with the value of what they track.
Why should you care?
ETFs typically have lower expense ratios than actively managed mutual funds since they simply track an index rather than employing a team to pick investments, and their exchange-traded nature offers intraday liquidity.
Real-life example
A Nifty 50 ETF holds the same 50 companies in the same proportions as the Nifty 50 index. If the Nifty 50 rises 10% over a year, the ETF's value should rise by roughly the same amount, minus a small tracking difference and its expense ratio.
Common mistakes
- Forgetting that ETFs need a demat and trading account, unlike regular (non-ETF) mutual funds which can be bought without one.
- Not checking an ETF's trading volume — low-volume ETFs can have wider bid-ask spreads, making buying and selling less efficient.
- Assuming all ETFs are low-cost — while typically cheaper than actively managed funds, expense ratios still vary between ETFs.
ETF vs regular (non-ETF) mutual fund
| Aspect | ETF | Regular mutual fund |
|---|---|---|
| How you buy it | On a stock exchange, needs demat account | Directly from the AMC or a platform, no demat needed |
| Price updates | Throughout the day, like a stock | Once a day, via NAV |
| Typical expense ratio | Usually lower (passively managed) | Varies; can be higher if actively managed |
| SIP-friendly | Less common, possible via some platforms | Very common and straightforward |
FAQ
Do I need a demat account to invest in ETFs?
Yes, since ETFs trade on a stock exchange like shares, you need a demat and trading account to buy and sell them.
Are ETFs actively managed?
Most ETFs passively track an index rather than being actively managed, though actively managed ETFs also exist and are less common in India.
What is tracking error?
Tracking error measures how closely an ETF's returns follow its underlying index — a lower tracking error means the ETF is doing a better job replicating the index's performance.
Can I do a SIP into an ETF?
It's less standardized than SIPs in regular mutual funds, since it involves manually placing periodic buy orders on an exchange, though some brokers now offer automated ETF SIP features.
See this concept applied to your own portfolio
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