ETF funds, or exchange traded funds, have emerged as a popular investment option for Indian investors seeking a diversified, cost-effective way to participate in the financial markets. While they share some features with mutual funds, ETF funds offer a different mode of investing and come with their own set of advantages and considerations.
In this article, we will explain what ETF funds are, how they work, how to invest in them, and how they can fit into a systematic investment approach like an SIP.
What are ETF funds?
ETF funds are pooled investment vehicles that track a specific index, commodity, or a basket of assets. These funds are listed and traded on stock exchanges, just like individual stocks. Each unit of an ETF represents a share in the underlying basket of securities.
For example, a Nifty 50 ETF will aim to mirror the performance of the Nifty 50 Index by holding the same stocks in the same proportion. As the index moves up or down, the value of the ETF reflects that change.
Key features of ETF funds
- Listed on exchanges: ETFs are traded on stock exchanges and can be bought or sold like shares.
- Market-linked pricing: The price of an ETF is determined by market forces, not by the mutual fund house.
- Low expense ratio: Since most ETFs are passively managed, they tend to have lower costs compared to actively managed funds.
- Transparency: The underlying holdings of ETFs are usually disclosed daily.
- Diversification: ETFs offer exposure to an entire index or sector through a single investment.
Types of ETF funds in India
ETF funds in India are available across different asset classes:
- Equity ETFs: These track market indices such as Nifty 50, Sensex, Nifty Next 50, etc.
- Debt ETFs: These invest in government securities or corporate bonds.
- Gold ETFs: These provide exposure to gold prices by investing in gold bullion.
- International ETFs: These track global indices or sectors and invest in overseas markets.
- Sectoral or thematic ETFs: These focus on specific sectors such as banking, pharma, or IT.
How to invest in ETF funds
Investing in ETF funds requires a slightly different approach compared to regular mutual funds. Here’s how you can start:
Step 1: Open a demat and trading account
You need a demat account to hold the ETF units and a trading account to place buy or sell orders on the stock exchange.
Step 2: Choose the right ETF
Evaluate the ETF based on factors like the underlying index, liquidity, tracking error, expense ratio, and past performance. Keep in mind, that any historical information or past data should not be taken as an indication or guarantee of any future performance
Step 3: Place your order
Once you’ve selected the ETF, you can place an order through your trading platform just like you would buy a stock. The units will be credited to your demat account.
Can you invest via an SIP in ETF funds?
While traditional mutual funds allow SIP through automatic monthly deductions, ETFs do not have a formal SIP mechanism. However, investors can still follow a disciplined SIP-like strategy manually.
For example, you can choose a fixed date every month to buy a fixed amount of ETF units from your trading account. This helps in cost averaging and builds the investment gradually over time.
Understanding the potential benefits and risks
Potential benefits
- Cost efficiency: ETFs generally have lower expense ratios compared to actively managed funds.
- Liquidity: You can enter or exit ETF investments any time during trading hours.
- Diversification: Even a single ETF unit can give exposure to a wide basket of securities.
Risks to consider
- Market volatility: ETF prices fluctuate based on market movements, and investments are subject to short-term volatility.
- Tracking error: There may be a small deviation between the ETF’s performance and the index it tracks.
- Liquidity risks: Some ETFs may have low trading volumes, leading to larger bid-ask spreads.
Can ETFs be used for long-term financial planning?
Yes, ETF funds can be a part of your long-term investment plan. They are suitable for investors who:
- Want exposure to index performance.
- Prefer lower-cost, passively managed instruments.
- Are comfortable managing investments through a demat and trading account.
If you have long-term goals such as retirement or education planning, equity ETFs can offer potential capital appreciation. For conservative investors, debt ETFs or gold ETFs may be more appropriate.
However, unlike regular mutual funds that offer SIPs and fund manager services, ETFs require a hands-on approach. This makes it important to review your portfolio periodically and invest in line with your risk profile.
Conclusion
ETF funds offer Indian investors a simple and transparent way to invest in diversified portfolios across asset classes. While they do not support traditional SIP formats, disciplined manual investing in ETFs can mimic the SIP experience and help build long-term wealth. Before investing, it is important to understand the nature of ETFs, evaluate associated risks, and ensure they align with your goals.
As always, it is advisable to consult a financial planner or investment advisor to determine whether ETF investing is suitable for your personal financial plan.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
