What is Exchange Traded Funds (ETF)?

ETF fund, or ETF funds, is an investment fund that is traded over the stock exchange much like other shares. The term ETF stands for "exchange-traded fund." In ETF full form, the ETF fund holds an array of assets in the form of either stocks, bonds, or commodities and attempts to replicate the performance of a particular index like the Nifty 50 or the BSE Sensex. In this article, we will explain what is ETF in stock market, what is the difference between it and mutual funds, what are the types of the ETF, and how it all works step by step.

How do ETFs Differ from Mutual Funds?

ETF vs mutual funds are both popular investment options, but they differ in how they are traded and managed. Probably the most common comparison in the investment world is comparing ETFs with mutual funds. Both of these investments pool investor funds into a diversified portfolio, yet there are some basic differences between the two. 

• Trading flexibility: ETFs are traded throughout the day on stock exchanges. In other words, during trading hours, market prices can be used to buy and sell shares. However, mutual funds are traded only in the after-hours trading session at a net asset value.
• Cost structure: Overall, the expense ratios of the ETF funds are lower than those of mutual funds. Most of the ETFs are passively managed and do not require active management like mutual funds do.
• Minimum investment: Mutual funds usually have minimum investments, whereas, for ETFs, just a single share can be bought, making them accessible to small investors.
• Tax efficiency: ETFs are much more tax-efficient compared to mutual funds, as they allow investors to buy and sell shares without attracting any capital gain taxes.

Types of ETF Funds

Now that you know, what are exchange-traded funds, let’s understand their types. Various types of ETF funds cater to different investment needs and strategies. Here's a simplified categorization of some common types of exchange-traded funds in India. 

• Index ETFs: Track specific market indices like Nifty or Sensex to obtain broad market exposure.
• Gold ETFs: These funds track the price of gold, and their investments are backed by physical gold. This makes it the easiest way by which investors can gain exposure to this precious metal.
• Sectoral or thematic ETFs: Invest in particular sectors like technology or healthcare; this helps investors eventually benefit from industry trends.
• International ETFs: These offer exposure to markets outside India and, hence, help Indian investors take advantage of global opportunities.
• Bond ETFs: Invest in a mixture of bonds as an alternative source of fixed income for investors seeking predictability and regular income.

How do Exchange Traded Funds (ETF) Work?

Helping to inform an investment choice is having an idea of how these securities work.

The second option for trading is exchange-listed ETFs. Their trading will occur throughout the day at market price on the stock exchange. This makes the investors prepared, as they will always be ready to quickly react to any type of change in the market.

• An ETF fund's net asset value is determined daily by the total value of underlying assets divided by outstanding shares.
• This is passively managed, tracking the index and not trying to outperform, always keeping a lid on fees.
• Stock exchange trading provides high liquidity; therefore, investment can either be entered or exited without largely affecting the price.
• Since the institution is buying or selling shares in large units, the market price will be much closer to the net asset value than if a number of them were buying or selling units.

How to Invest in an ETF in India?

Investing in ETF funds in India is easy if you follow these easy steps. 

• Open a Demat account: To invest in ETFs, you need to open a demat account and trading account with your stock broker. The demat account will hold all of your electronic ETF shares.
• Choose an ETF: Based on the various investment goals, you can select the types of ETFs available, like index, gold, sectoral, etc. First of all, check the past performance, the expense ratio, and liquidity before you finalize.
• Place an order: Use the trading account to place an order for the purchase of the desired ETF during market hours. You could use any type of order, including either a market or limit order, depending on your strategy.
• Check your investment: Monitor performance from your ETF as well as market conditions. Look at your investment strategy every day to check your portfolio so far and to adjust where necessary.
• Understand the cost: Understand the cost, which includes brokerage fees and the expense ratio associated with the ETF. These costs will eat away at your returns over time.

Advantages and Disadvantages of ETFs in India

Here are some of the advantages and disadvantages of ETF funds mentioned.

Conclusion
Exchange-traded Funds (ETFs) can be a flexible and cost-effective way through which an investor can ensure exposure to a diversified portfolio. It has increasingly gained popularity among individual investors due to its unique feature structure, wherein it combines the best features of mutual funds and stocks. You can explore different types of ETFs to choose from on a good share market app. Understand ETF meaning, how ETF works, including the various types of ETF funds, the pros and cons of each, and how they differ from traditional mutual funds, to make smart investment decisions.