How does an ETF work?

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Short Answer

ETF is an investment instrument that tracks a group of securities from a particular asset class and performs according to it. It is managed by a Fund manager who makes sure that the ETF tracks the underlying asset accurately. ETFs are listed on the Stock Exchanges therefore one can buy & sell them within the market hours at their desired prices.

Detailed Answer

What is an ETF?

An ETF or (Exchange-traded Fund) is a type of investment tool that mostly tracks an Index, commodity, or a specific sector and is listed on the Stock exchanges. ETFs are a pool of Funds (similar to Mutual Funds) actively or passively managed by a Fund Manager who ensures that the Fund tracks the underlying asset accurately.

Some examples of ETFs are Nifty50 ETF, BankNifty ETF, S&P 500 ETF, etc.

The 3 types of ETF’s that are the most popular among investors are-

  • Equity ETF
  • Commodity ETF
  • Debt ETF

Different types of ETFs are made to track different asset classes. For example, a Gold ETF will track the price of Gold and will move accordingly. Similarly, a Nifty50 ETF will track the Nifty 50 Index and move accordingly.

How an ETF work?

ETFs are called Exchange Traded Funds because they are listed on the Stock exchanges from where an individual can buy and sell them within the market hours. The price of these ETFs fluctuates every second as the underlying asset moves, unlike Mutual funds that update their NAV (Net Asset Value) only at the end of the day. One can get their desired price while selling their ETFs by placing a Limit order but one has to sell a Mutual Fund only at the NAV.

Difference between ETF & Mutual Funds

  1. ETFs are usually low-cost compared to Mutual funds because most of the ETFs are passive funds that track a particular Index hence the expense ratio is less.
  1. ETFs can be bought with margin provided by the Stockbrokers by one cannot buy Mutual Funds with margin.
  1. An ETF can be shorted for hedging, but Mutual funds cannot be shorted. One can only buy & sell mutual funds.
  1. The minimum quantity of ETFs that can be bought is “1” whereas most mutual funds have a high minimum investment amount of “1000” - “5000” Rupees.

Let's take an example of HDFC Nifty50 ETF.

This ETF falls under the Equity category as it tracks the Nifty 50 Index and moves accordingly to the Nifty 50. One can buy and sell 1 unit of this ETF at any point of time during market hours. When one buys this ETF the fund purchases the companies under Nifty in the same proportion. By this, it ensures that the direction of the ETF and Nifty50 is always the same. The current price of this ETF is Rs 158 which is roughly 1/100 the price of the Nifty50 Index. Hence one can buy 1 ETF for Rs 158 at the current market price and get exposure to all the 50 stocks in the Nifty50 index.


ETS are alike mutual funds but offer better features. It offers the flexibility of “Entry” and “Exit” price to the investors, as well as the Expense Ratio, is much lower compared to Mutual Funds which makes it an ideal option for Passive investing.

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