SIP in ETF: Benefits, Challenges, And Popular Options In India

In recent years, many Indian investors have taken to Systematic Investment Plans (SIPs) in mutual funds for their convenience and disciplined approach. At the same time, Exchange-Traded Funds (ETFs) are also receiving growing investor interest as they enable diversified and relatively low-cost exposure to various indices and sectors. Now, investors can combine the strengths of both, by setting up SIPs in ETFs. This approach may offer a systematic and relatively affordable route to passive investing, though like all market-linked investments, it comes with risks.

In this article, you’ll find an easy-to-follow guide on how ETF SIPs work, the potential benefits for your portfolio, and some key challenges to consider when navigating this investment strategy in the Indian market.

Table of contents

• What is an ETF?
• What is an SIP in ETFs?
• Is SIP possible in ETFs?
• How does an SIP in ETFs work?
• Benefits of starting an SIP in ETFs
• Challenges and things to know
• SIP in ETFs vs SIP in mutual funds
• Who should consider SIP in ETFs?

What is an ETF?

First, the basics. An ETF, or Exchange-Traded Fund, is a pooled investment vehicle that tracks an underlying index or asset. Instead of buying all the individual stocks in, say, the Nifty 50 or BSE Sensex, an investor can buy a single ETF unit that broadly reflects the same basket and seeks to replicate its performance, subject to tracking error, which is the difference between the index’s performance and that of the fund. What sets ETFs apart from regular mutual funds is that they are listed and traded on stock exchanges throughout the day.

What is an SIP in ETFs?

An SIP in ETF is a method where an investor commits to investing a fixed amount of money at regular intervals – say, monthly – to buy units of an ETF. It’s important to note that unlike SIPs in mutual funds, which are created and managed at the AMC level, SIPs in ETFs are not an AMC-level facility. Because ETFs trade on the exchange like stocks, they do not have a built-in SIP mechanism.
However, given the growing adoption of SIPs among Indian investors, many brokers have introduced SIP-like features that automate ETF purchase orders on a predetermined date. These facilities are offered by the broker’s platform, not by the ETF issuer.

While some platforms automate ETF buy orders, others may require manual execution.

Read Also: How to Invest in ETFs: Steps & Key Benefits

Is SIP possible in ETFs?

Setting up a systematic plan for ETFs is possible, provided your chosen broking platform offers it. The ETF SIP transaction executed via the trading platform of the broker. On a set date, the broker buys your chosen ETF units from the stock market based on your instructions (either a set quantity or a set rupee value). However, it is mandatory for the investor to have a demat and trading account, and importantly, must have enough cleared funds in their trading ledger before the order is placed.

How does an SIP in ETFs work?

The exact process of setting up and managing an SIP in an ETF may differ from one broker to another, but here are some typical aspects:

• Account requirement: You typically need an active demat and trading account with a broker.
• ETF selection: You log into the broker's platform and find the relevant section. From there, you select the specific ETF you want to invest in.
• Instruction: You define the SIP parameters such as the frequency, date of purchase, and investment type. You must choose to invest either by amount or by quantity.
• Execution: On the scheduled date, the broker's system automatically triggers an order to buy the ETF units. It is your responsibility to have adequate cash in the trading account. If the balance is low, that month's SIP order will simply fail.
• Unit allotment: Once purchased, the units are credited to your demat account.

A major difference between an ETF SIP and a mutual fund SIP is the applicability of fractional units. Mutual funds may give an investor allotment in fractional units. ETFs, however, trade on the exchange just like stocks – hence one can only buy whole units.

So, if one sets up an 'Amount' SIP for Rs. 1,000 when the ETF price is Rs. 180, the platform will buy 5 units (costing Rs. 900). The remaining Rs. 100 will sit uninvested in the trading account. Note that brokerage fees and other charges may apply, which could affect the actual number of units purchased.

Benefits of starting an SIP in ETFs

Applying the SIP discipline to ETFs may offer several potential benefits.

• Rupee cost averaging: This is considered one of the key benefits of SIPs. By investing a fixed sum regularly, you automatically buy more units when the market is down and fewer units when it's up. This may help reduce the impact of market volatility and average out your purchase price over time. However, rupee cost averaging does not guarantee profits or protection against losses in declining markets.
• Low cost: Most ETFs in India are passively managed – they simply replicate an index and mirror its portfolio. This generally results in lower expense ratios compared to actively managed mutual funds.
• Diversification: A single ETF unit can give you exposure to an entire index (like the Nifty 50 or the BSE Sensex), a specific theme (like banking), or a commodity (like gold).
• Investment discipline: Automating the purchase takes emotion and guesswork out of the equation. This may help build a disciplined habit of regular investing.

Challenges and things to know

• Liquidity and spreads: While major index ETFs (like those benchmarked to Nifty 50 or BSE Sensex) typically have higher liquidity, many other thematic or niche ETFs may trade in lower volumes. This may cause a wide 'bid-ask spread' – the gap between the buy price and the sell price – which could increase trading costs.
• The fractional unit problem: ETFs can only be bought in whole units. A small portion of your intended SIP amount might sit idle as cash each month, which may create a slight drag on potential compounding.
• Broker dependency: The system works only as well as the broker's platform. The reliability, user-friendliness, and features may vary a lot from one broker to another.
• Transaction costs: Every SIP instalment is a trade on the exchange. This means one incurs costs such as brokerage and exchange fees on the transaction.
• Tracking errors and market risks: ETFs may not exactly mirror underlying indices owing to tracking error. ETFs are also subject to market volatility.

SIP in ETFs vs SIP in mutual funds

For any passive investor, the choice usually boils down to an ETF SIP versus an SIP in a regular index fund. Here is a direct comparison.

Who should consider SIP in ETFs?

• The DIY investor: Individuals who may be comfortable managing their own demat and trading accounts and who understand basic stock market trading mechanics.
• Cost-conscious investors: Investors who may treat expense ratio as a top priority, and who may be willing to handle the extra steps to reduce costs.
• Disciplined investors: Investors who may value diversification along with flexibility and affordability and willing to be disciplined in their investment habits to build long-term potential wealth.

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

Conclusion

The option to start an SIP in ETFs may give Indian investors another relatively low-cost, and transparent tool for potentially building long-term wealth. This route merges the discipline of SIPs with the raw efficiency of passive ETFs. For the investor who is informed and diligent, an ETF-based SIP strategy may be a part of a diversified portfolio.

FAQs

Which is preferable: an ETF SIP or a Mutual Fund SIP?

It depends on the investor. A mutual fund SIP (in an index fund, for comparison) is simpler, offers full automation, and allows for fractional units. An ETF SIP usually has a lower expense ratio but requires a demat account, active funding of that account, and you can only buy whole units at live market prices.

Are there specific tax advantages for SIPs in ETFs?

Taxation depends on the ETF's assets. For equity ETFs, holding over 12 months makes gains long-term (LTCG), taxed at 12.5% (on gains above Rs. 1.25 lakh annually). Gains in under 12 months are short-term (STCG) and taxed at 20%.