An ETF works like an index mutual fund but trades like a stock. It gives you diversification like a mutual fund but liquidity like a stock.
A great part of stock market investors buys multiple stocks to create a portfolio. Their target is to diversify the portfolio in a way that risk reduces. Doesn’t it make you wonder if you could buy the entire portfolio in one go?
Well, this is very much a possibility. An exchange-traded fund (ETF) is an investment product that allows you to buy ‘n’ a number of stocks in an instant. You buy certain units of an ETF of your choice, and your money gets invested in all stocks comprising the ETF.
Sounds similar to mutual funds, but is it really? Let’s find out!
Content:
- ETF Meaning
- ETF Example
- Types of ETF in India
- ETF Advantages
- ETF Disadvantages
- How to invest in ETF in India
- Quick Summary
ETF Meaning
You have multiple indices in the stock market consisting of a certain number of stocks. For example, Nifty50 has the top 50 stocks as per the market capitalization, such as Reliance Industries, Tata Consultancy Services, HDFC Bank, and Hindustan Unilever.
Nifty Next50 comprises the next 50 stocks, such as HDFC AMC, DLF, United Spirits, MRF, InterGlobe Aviation, etc. Bank Nifty has 12 banking stocks, such as HDFC Bank, ICICI Bank, Kotak Mahindra Bank, and Bandhan Bank.
Find out the Nifty 50 companies.
When you have a mutual fund investing in all stocks of an index, it is called an index fund. A fund house can create the same arrangement and get it listed on stock exchanges. The listed investment product is called an ETF.
Thus, an ETF is a security that tracks an index and trades on exchanges as a unit. For example, Nifty50 ETF trades on the BSE and NSE, and any money invested in this ETF goes into the 50 stocks of Nifty in the same proportion as those are on the index. Mutual fund houses such as HDFC AMC, Edelweiss AMC, etc, create ETFs. You may have multiple ETFs from various fund Houses tracking the same index.
In a nutshell, an ETF works like an index mutual fund but trades like a stock. It gives you diversification like a mutual fund but liquidity like a stock.
ETF Example
Some of the popular ETFs include:
- HDFC Sensex ETF
- SBI ETF Nifty Junior
- UTI Nifty ETF
- Motilal Oswal Midcap 100 ETF
- Motilal Oswal NASDAQ 100 ETF and
- Nippon India ETF Nifty BeES.
Types of ETF in India
There are four types of ETFs in India
- Equity ETFs
- Gold ETFs
- Debt ETFs
- Currency ETFs, and
- Global Index ETFs.
Equity ETFs
Equity ETFs track the indices in the stock market. They invest in stocks. The taxation is similar to equities – short-term capital gains tax if you sell before one year and long-term capital gains (LTCG) tax after one year.
Gold ETFs
Gold ETFs such as Invesco India Gold ETF and SBI – Gold ETF invest in physical gold assets. They trade on commodity exchanges. The tax treatment is the same as it is on physical gold – STCG tax as per the slab rate if sold before three years and LTCG tax at 20 percent with indexation or 10 percent without indexation.
Debt ETFs
The products investing in fixed-income securities, such as government bonds and debentures, are called Debt ETFs. Bharat Bond ETFs and CPSE ETFs are examples of debt ETFs. The tax treatment is similar to the gold ETFs.
Global ETFs
There are some ETFs in India that track international indices, such as NASDAQ 100 and S&P 500, thus giving an easy option to take exposure to global equities. Global ETFs are taxed like gold and debt ETF
Currency ETFs
Currency ETFs such as WisdomTree Indian Rupee Strategy Fund allow one to invest in global currencies in a cost-effective and simpler manner. These ETFs take exposure in cash deposits and short-term bonds underlined in currency and overseas derivative contracts.
ETF Advantages
Low Cost
The expense ratio on ETFs is usually 0.5 percent compared to 1-2 percent on actively managed mutual funds.
Liquidity
The price/NAV of a mutual fund is declared only once at the market close, but ETF units fluctuate during market hours. One may buy and sell ETF units anytime during market hours.
Learn more about Liquidity in the Stock Market.
Transparency
Mutual fund holdings are declared on a monthly basis. However, the holdings in ETFs are visible on a real-time basis. The holdings will be weighted in an equal proportion as those are in the underlying index. The ETF holdings get rebalanced when index constituents change.
ETF Disadvantages
Average Market Return
Since ETFs invest in an underlying index, the returns will be similar to the benchmark index. There will not be the much-coveted alpha that fund managers or investors target when they actively pick stocks.
Demat Account Needed
Mutual fund investment does not require you to open a demat account. However, ETF investment is done with a demat and a trading account.
Tracking Error
While ETFs reflect the returns of an underlying index, there could be some discrepancy which is known as a tracking error.
How to Invest in an ETF in India?
You can invest in ETFs via Alice Blue, all you have to do is, Open a Free Demat Account in 15 Minutes and start buying ETFs. Also, at the lowest brokerage rate of ₹ 15 only.
It is pretty easy to open an account with Alice Blue. Open your Free Demat Account Now!
Once you have opened your account, you need to log in to the trading platform and search for the chosen ETF in the search bar. You can buy it exactly the same way as you do the stocks. ETFs trade at an indicative NAV on a real-time basis.
Place your order. You will get the units at the real-time NAV. The ETF will get credited into your demat account on T+2 Days. You may sell the ETFs anytime you want. You receive the proceeds of your sale in your designated bank account on T+2 Days.
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, and hence we bring you the important topics and areas that you should know:
Quick Summary
ETFs are a cost-effective and safer route to take exposure in an investment product. Although these are liquid investments, you should still have a longer time horizon when you are investing in ETFs.
One of the important aspects when choosing an ETF is comparing the tracking error and expense ratio. Go for the ones with lower tracking error and expense ratio. If direct investment in equities or debt products scares you and you do not want the mutual fund set-up, ETFs are the way to go.
