Beginners Guide To Investing In ETFs In India

If you are beginning your investment journey and want exposure to the broad market without tracking multiple individual companies, investing in ETFs may be a suitable entry point. Exchange traded funds (ETFs) pool money from multiple investors and invest it in a portfolio that mirrors a stock market index. The units of an ETF trade on stock exchanges like any listed share.

This article explains what an ETF is, how it differs from stocks and regular mutual funds, and the major ETF categories available in India. It also covers practical considerations such as how ETFs function, their potential benefits and risks, a structured selection checklist, and an updated overview of taxation rules that apply to different ETF types.

Table of contents

• What actually is an ETF?
• ETFs vs. stocks vs. mutual funds
• ETF categories
• Advantages of ETFs
• How to select an ETF for yourself?

What actually is an ETF?

An ETF is an open-ended, market-linked fund that seeks to replicate the performance of an underlying index (subject to tracking error). ETF units are listed and traded on the exchange throughout market hours, which gives investors the ability to buy or sell at prevailing market prices.

This intraday tradability is what differentiates ETFs from regular mutual funds that transact only at end-of-day NAV. ETFs do have a closing NAV, but throughout the day, prices fluctuate with market activity. The value of an ETF during the trading day is called indicative NAV (iNAV), which is published periodically by exchanges or AMCs. iNAV helps investors understand the approximate fair value of an ETF during the day, although actual execution happens at the traded market price.

Read Also: What Are Sector ETFs? Meaning, Features & How to Invest?

ETFs vs. stocks vs. mutual funds

These three investment options offer different ways to access the markets:

• Ownership and diversification:
  • Stocks: You hold shares of individual companies. Exposure depends entirely on the companies you choose, and your diversification depends on how many shares you select.
  • ETFs: A single purchase offers diversified exposure because each ETF corresponds to an index.
  • Traditional mutual funds: These offer diversified portfolios but do not provide intraday trading. Transactions occur directly with the AMC or through a distributor at the end-of-day NAV.
• How you transact:
  • Stocks and ETFs: You buy and sell through a demat and trading account on the NSE or BSE.
  • Mutual Funds: You invest through AMC or RTA platforms, online marketplaces, or distributors. A demat account is not required for regular mutual fund investing.
• Pricing:
  • Stocks and ETFs: Prices move in real time according to market demand and supply. ETFs also disclose an iNAV multiple times a day to provide a reference point.
  • Mutual Funds: All purchases and redemptions occur at the end-of-day NAV.
• Costs:

ETFs tend to have relatively lower costs compared to actively managed funds, but this varies by scheme. Investors also incur brokerage, exchange fees, and the potential impact of bid-ask spreads when trading ETFs.

• Minimums and SIPs: ETFs do not have AMC-set minimums on exchanges; they are bought in whole units. Investors without a demat account may consider fund-of-fund (FoF) schemes offered by AMCs that invest in ETFs. These FoFs allow systematic investing, though they come with their own expense ratios and tax rules.

ETF categories

When exploring ETF options, it may help to understand the broad categories available. These categories may be aligned with different goals and risk levels depending on your plan.

• Equity index ETFs: Track broad market indices or segments such as large cap, mid cap, small cap, or total market indices.
• Factor ETFs: Use predefined rule-based approaches such as value, quality, momentum, or relatively low volatility factors.
• Sector and thematic ETFs: Offer exposure to specific themes such as banking, PSU enterprises, or energy-related sectors.
• Debt ETFs: Hold portfolios of government securities (G-sec), state development loans (SDLs), or corporate bonds, offering fixed-income exposure through exchange-traded units.
• Commodity ETFs (gold or silver): Track domestic bullion prices through regulated structures.
• International ETFs: Some India-domiciled passive schemes provide exposure to overseas indices directly or through feeder structures.

Read Also: Index Funds vs ETFs – Which One Should You Pick?

Advantages of ETFs

Here are some potential benefits of investing in ETFs:hours. iNAV publication provides a reference point that may help investors avoid transacting if there are extreme price deviations.

• Relatively lower ongoing costs for many passive categories: Since ETFs replicate an
• Diversified exposure in one trade: A single ETF investment spreads exposure across multiple securities represented in the tracked index.
• Intraday liquidity and transparent pricing: Investors may enter or exit during market index rather than actively select securities, their expenses may be relatively lower than some actively managed funds.
• Transparent structure: Indices and ETF portfolio holdings are publicly available, and SEBI mandates tracking error and tracking difference disclosures, which enhances visibility into replication quality.

Important caveats:

• Liquidity varies: Some ETFs, especially those tracking narrow or less-traded indices, may have limited trading volumes and wider bid-ask spreads.
• Tracking error: This is the difference between the ETF’s performance and that of the index. This may slightly affect potential returns over time.
• Market risk: If the underlying index or assets decline in value, the ETF will also decline.
• Trading costs: Expense ratios, taxes, demat charges, and spreads may add to the total cost of ownership.
• Taxation differs across ETF types: Tax treatment is determined by whether the ETF qualifies as equity-oriented or debt-oriented under current tax law.

How to select an ETF for yourself?

Here is a practical checklist for investing in ETF:

• Start with your financial objective and time horizon. Equity ETFs may be considered for long horizons, while debt or commodity ETFs may be considered for specific allocation needs.
• Understand the index methodology. Review how constituents are selected, weighted, and rebalanced.
• Review tracking error and tracking difference. Check AMC disclosures across multiple timeframes.
• Evaluate expense ratios. Lower costs may support long-term efficiency, but cost should not be viewed in isolation.
• Check market liquidity and spreads. Assess average traded value, depth, and spread. Limit orders may help when spreads are wide.

Conclusion

ETFs offer a way to access diversified exposure through exchange-traded units. Connecting your ETF choice to a clear financial goal may help bring structure to your plan. It is useful to understand the index rules before investing. Reviewing tracking metrics gives clarity on how closely the ETF follows its benchmark. Knowing the applicable tax rules ensures you understand how your gains will be treated. Investors may also explore a combination of broad-index ETFs and limited satellite exposures depending on their objectives. Always refer to regulatory updates and rely on scheme documents, SEBI circulars, and AMFI resources for accurate and current information.

FAQs

What is an ETF and how does it differ from mutual funds?

An ETF is a market-linked fund that tracks an index or asset and trades on the exchange like a share. Investors buy or sell ETF units in real time through a broker, and units are held in demat form. A traditional mutual fund, including index funds, is bought or redeemed from the AMC at end-of-day NAV instead of a market-determined price.

Do I need a demat account to invest in ETFs?

If you want to purchase an ETF directly on the NSE or BSE, a demat and trading account are required. Those who prefer to avoid opening a demat account may consider FoF schemes that invest in ETFs or index funds that, like ETFs, replicate an index.

How may I select an ETF based on my financial goals?

Start with clarity on your objective and your time frame. Then shortlist ETFs based on index methodology, tracking error and tracking difference, expense ratio, liquidity indicators, and total ownership cost. Market orders may not always be suitable in low-liquidity ETFs, so limit orders may help control execution. Using iNAV as a reference may help gauge relative pricing.