With the financial market constantly changing, finding smart ways to grow your money is more important than ever. You might have heard people mention ETFs when talking about investing. It might be a bit overwhelming initially, but it’s a pretty straightforward concept.
What is ETF in the Stock Market? An Exchange-Traded Fund (ETF) is an investment fund that invests in different stocks or bonds, traded on a stock exchange, all at once. They are easy to trade, usually have lower fees, and are a smart choice for people who want to build their savings over time without any trouble.
This blog breaks down everything you need to know from the ETF meaning and benefits to the types available in India, taxation rules, and how to start investing.
Table of Contents
What is an ETF?
An Exchange-traded fund (ETF) is a type of investment fund that works like a mutual fund but trades like a stock. Think of it as you are buying a ready-made portfolio filled with assets like equity stocks, bonds, commodities, other fixed-income securities, or a mix of all. In India, ETFs track market indices like the Nifty 50, Nifty 100, and BSE Sensex, among others.
ETFs are considered marketable securities as they allow investors to buy and sell multiple assets like stocks, bonds, etc., on exchanges like the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), similar to stocks. Like mutual funds, ETFs have benefits, such as lower fees, better tax efficiency, and trade at any time during the day.
In the case of ETFs, investors get a clear picture of their holdings, and these are usually passively managed to match a particular benchmark’s performance. Investors can choose from a variety of ETFs to meet their investment objectives and risk tolerance, making them a flexible and top pick in today’s financial markets.
Types of ETFs
1. Equity ETFs
Equity ETFs put money into a basket of company stocks, also known as shares. These funds track the performance of the wider market or a sectoral equity index such as Nifty Bank, Sensex, Nifty 50, etc. It combines the flexibility of stock investment and the simplicity of equity mutual funds and can be considered by investors aiming for long-term wealth creation through ETF investment.
Examples of some Equity ETFs are Edelweiss Exchange Traded Scheme – NIFTY, ICICI Prudential NIFTY ETF, UTI Sensex ETF, etc.
2. Commodity ETFs
Commodity ETFs are a type of fund that invests in particular commodities or several different commodities, such as oils, coffee, precious metals, livestock, etc.
Examples of some Commodity ETFs are Nippon Gold ETF, HDFC Gold ETF, ICICI Pru Silver STF, etc.
3. Debt ETFs
These are also popularly known as fixed-income ETFs, generally following an index, such as the Nifty or Government Bond Index, and invest in the same bonds in the same proportions as the index. These funds provide exposure to fixed-income securities for investors who need cost efficiency, diversification, and stability.
Examples of some Debt ETFs in India are: Debt ETFs like Nippon India ETF Nifty 1D Rate Liquid BeES, DSP NIFTY 1D Rate Liquid ETF, and Bharat Bond ETFs.
4. International ETFs
If an investor wants to invest in a foreign market through an ETF, international ETFs are the best option. These are simple investment products that give Indian investors exposure to international indices. It has a mix of all the assets, including equity, commodities, bonds, and trades on the stock exchange, just like normal stocks.
Examples of Global ETFs are Motilal Oswal Nasdaq 100 ETF, Mirae Asset NYSE FANG+ ETF, Nippon Hang Seng ETF, etc.
5. Smart Beta ETFs
Smart Beta ETFs are funds that track many weighting methods to create portfolios, compared to the traditional cap-weighted indexes. They are a blend of active and passive investing that changes technical or fundamental aspects such as value, size, volatility, and momentum.
Examples of Smart Beta funds are ICICI Prudential Nifty Low Vol 30 ETF and Nippon India ETF NV20.
6. Leveraged and Inverse ETFs
Leveraged and Inverse ETFs focus on boosting the returns of an underlying index or providing opposite returns to the index’s performance, used for short-term trading. Combining both offers traders useful investment possibilities to maximise short-term gains and market trends.
How to Get Started With ETFs
Here are the steps on how to invest in an ETF:
Zerodha, Groww, and Upstox are some of the platform you can go for when opening an account.
Step 2: Sign Up For a Demat Account
Before proceeding to invest in ETFs, you need to have a demat account. Here you will be asked for KYC. The platform’s interface and services might be new for you, so familiarise yourself first with it.
Step 3: Explore Your Options
Check different ETF options on your demat account that are suitable for your financial objectives and investment timeframe. Check factors like ETFs’ expense ratio, underlying asset, and liquidity, and choose the one that meets your needs.
Here is an example:
| ETF Name | Underlying Assets | 1 Year Return | Expense Ratio | Tracking Error |
| SBI Nifty ETF | Nifty 50 Index | 15.8% | 0.17% | 0.11% |
| Bharat Bond ETF | Government bonds | 8% | 0.12% | 0.21% |
SBI Nifty ETF might be a better choice if your priority is higher returns, but for lower expenses, Bharat Bond ETF is preferred.
Step 4: Enter Your Order
Log in to the trading account and visit the order placement section, and enter the name of the ETF you want to purchase.
Step 5: Quantity and Price
The number of ETF units you want to buy, mention it in the order entry form. You can use a limit order and set the desired price per unit, too. Verify the order details to ensure that they match your investment criteria.
Step 6: Track and Adjust
Once the order is placed, you can monitor your investment status through your trading account. Recent updates, changes in price, and market news keep you updated about everything that may affect your investment. Furthermore, regularly check your investment portfolio.
Popular ETFs in India
Here are the top popular ETFs in India:
Future of ETFs in India
The Indian ETF market is growing fast. Although ETF was introduced in 2001 in India, it has made a significant impact on the Indian economy. The trading volume has jumped from ₹26,139 crore in FY 2016-17 to ₹1,83,676 crore in FY 2023-24, which is an increase of about 600%. The Equity ETF’s AUM has consistently increased over the last 5 years.
The ETF market is on track to exceed ₹16.8 lakh crore (AU$ 300 bn) in 2025. The Indian ETF market has seen growth over the years, expanding by over 30% yearly, indicating India’s shift towards global passive investing norms. India-focused ETFs are growing in popularity, with increased government spending and monetary easing boosting market growth.
With projections indicating a doubling of the Indian Mutual Fund industry’s size to Rs 100 lakh crore by 2030, it is expected that ETFs and index funds will be a major force behind the growing penetration, contributing 25-30% to the mutual fund industry’s total AUM.
Benefits of ETFs
1. Liquidity
One of the most beneficial aspects of ETFs is their liquidity, as they can be purchased and sold during the trading day at market prices, providing investors with flexibility and ease of trading.
2. Diversification
These funds allow investors to diversify across horizontals, i.e., it diversifies the portfolio to an entire Index instead of a single stock. This helps investors to mitigate the risk associated with a single stock.
3. Transparency
Most ETFs disclose their holding daily, allowing investors to see which securities they are investing in exactly and make better decisions about their portfolio.
4 Cost Effectiveness
Instead of researching individual stocks or bonds available in the market, investors can invest in a single ETF that reflects the performance of a particular index.
5. Elimination of Unsystematic Risks
By diversifying your investment into a variety of stocks, bonds, commodities, etc., ETFs help in spreading the risk across a broader range of assets. Such as, a loss in one particular asset can be offset by profits in other assets.
Limitations of ETFs
1. Market Volatility
The impact of market volatility on an ETF depends mostly on the assets within the ETF, such as bonds, equity, commodities, etc., and how they respond to the market conditions. For example, during a bull market, the impact of volatility on ETF is positive, while during a bear market, the prices of market-linked assets steadily decline.
2. Trading Costs
For regular traders or investors trading small amounts, trading costs can be a disadvantage. Although ETFs have a lower expense ratio compared to actively managed mutual funds, brokerage commissions and bid-ask spreads can add up, mainly with high trading activity.
3. Tracking Error
Tracking error refers to the difference between an ETF’s performance and the performance of its underlying benchmark index. ETF funds with high tracking error typically produce returns much lower than the benchmark index.
How are ETFs Taxed in India?
1. Dividend Income from ETFs
Dividends from ETFs were liable to a Dividend Distribution Tax (DDT) of 15% before the FY 2020-21. But DDT was abolished by the Finance Act 2020, so currently, the dividend income is added to the total income of the investor and is taxed according to their applicable income tax slab.
2. Tax Structure on Capital Gains
The tax structure on capital gains for Equity ETFs, Gold ETFs, Debt ETFs, International ETFs, and other ETFs is similar.
- Short-Term Capital Gains (STCG): The gains fall under Section 111A of the Income Tax Act and are subject to 15% – 20% tax if you sell units within 12 months of purchase.
- Long-Term Capital Gains (LTCG): When you sell the ETF units after holding them for a year, Section 112A is applicable. In this scenario, profits above Rs. 1.25 lakh in a fiscal year are taxed at 12.5% without indexation.
Should You Invest in ETFs?
If you want easy market access, low fees, and built-in diversification, ETFs can be a smart choice, but they are not for everyone. Consider your investment goals, risk appetite, and time horizon before diving in.
Conclusion
ETFs simplify investing. They provide access to a wide variety of markets without the stress of picking individual stocks or timing your entry. With a basic understanding and a bit of planning, ETFs can be a powerful tool in your investment journey.
FAQs
Q1. How do ETFs work?
They collect funds from multiple investors to buy a collection of assets, then divide that into shares traded on stock exchanges.
Q2. Where to buy Exchange Traded Funds?
You can buy ETFs on the stock market via a Demat and trading account with a registered broker.
Q3. Is an ETF better than a stock?
In terms of risk, ETFs are better as they are typically more diversified than stocks. But if you aim to achieve higher returns, stocks are a better option.
Q4. What is Gold ETF?
It tracks the price of gold and lets you invest without physically holding the metal.
ETF vs Index Fund: What’s the difference?
Both track an index, but ETFs offer real-time trading while index funds process orders only at day-end.
How are ETFs different from mutual funds?
ETFs are traded throughout the day like stocks and usually have lower fees. In contrast, mutual funds only trade once every day at the NAV price.