As the name suggests, an ETF or Exchange-Traded Fund is a type of investment fund that is traded on a stock exchange, similar to shares of a company.
ETFs may track an index, commodities, bonds, or other securities.
Most ETFs are passively managed and aim to replicate the performance of the underlying index or asset they track.
For example, the Nippon India ETF Nifty 50 BeES is an exchange-traded fund that tracks the Nifty 50 Index. Investors can buy and sell units of the ETF through their trading platforms during market hours.
Benefits of ETFs
Lower Expense Ratios
ETFs generally have lower administrative and management costs because most ETFs are passively managed and do not aim to actively outperform the market.
Trading Flexibility
ETFs can be bought and sold on the stock exchange during market hours, similar to stocks. Investors can track price movements and trade ETFs anytime during market hours.
Passive Investment Approach
Most ETFs follow a passive investment strategy where the portfolio is periodically adjusted to match the composition of the underlying index.
Drawbacks of ETFs
Demat and Trading Account Requirement
Investors need a demat and trading account to invest in ETFs, unlike mutual funds where such accounts are generally not mandatory.
Brokerage and Transaction Costs
Investors may incur brokerage charges and other transaction costs while buying or selling ETFs on the stock exchange.
Tracking Error and Market Risk
Since ETFs are passively managed, their performance may slightly differ from the index they track due to tracking error and expenses. ETFs are also subject to market risks.
Difference Between ETFs and Index Funds
Expense Ratio
ETFs generally have lower expense ratios compared to index mutual funds because of their passive structure.
Investment Mode
ETFs are traded on stock exchanges through a demat and trading account, whereas index funds can be purchased directly from the AMC without a demat account.
Liquidity
ETFs can be bought and sold during market hours like stocks, while index mutual funds are purchased and redeemed based on the NAV declared after market hours.
Types of Plans
Index mutual funds usually offer both direct and regular plans, whereas ETFs do not have such classifications.
Before investing, investors should understand that ETFs are also subject to market risks, and returns are not guaranteed.
To learn more about mutual funds in a simple and beginner-friendly way, explore our Mutual Fund Investor Section, where we have answered 100+ mutual fund questions in an easy and well-structured format.
