How does an ETF work?

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.

Conclusion

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.

Tagged With: ETFequity etfcommodities etfstock exchangesmutual fund
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Related FAQs

How are ETFs different from Mutual Funds?

ETFs (Exchange Traded Funds) and Mutual Funds are similar investment vehicles that provide the investors various features. Both have their benefits and shortcomings. ETFs are a good option for passive investors who want to invest in a particular Index or Sector without much rebalancing. On the other hand, Mutual Funds are a better option for active investors who are more active with their investments. One can switch between funds according to their current strategies.

Why are ETF or Exchange Traded Funds not popular in India?

Exchange traded fund is a freely marketable security which tracks a particular index, commodity, bonds or combination of assets. they aren't popular as there is no additional tax incentives, not enough liquidity, under performs most of the time, lack of choices, lack of institutional interest, costs are low but not enough and lack of awareness.

Are ETFs only for stocks?

ETFs are a financial instrument made to track an underlying asset and provide similar returns based on the performance of the underlying. ETFs are listed on stock exchanges which make it easier to buy and sell at desired prices. ETFs are not only limited to stocks but cover a wide range of investment avenues like Commodities, Bonds, etc.

Are market highs good to invest in Equity mutual funds?

Understanding the relative position of the market, the absolute values do not matter much. What matters is what is the earnings multiple, currently the market is trading at, popularly captured by a metric called P/E ( Price to earnings).

Is Groww App Safe for Mutual fund and Stock Investing?

Yes, Groww app is completely safe for mutual fund, stock investing and trading. As a popular mutual fund investment plaftorm, Groww established itself quite well in the past few years. Now, it has also enetered the stock broking space so it's really good to see new entrants amid existing top discount brokers in India.

Which is better investing in equity, mutual funds, or keeping money in banks?

Equity and mutual funds are perfect if you want to invest in companies while seeing your money grow in a short period. Moreover, the chances of compounding your investments are higher. But the risk associated is equally greater considering the growth of companies and their performance in offering returns. But then keeping money in the bank is the safest way to keep your earnings. But then, due to inflation and low returns on interest, that value of the money kept might be cut down drastically.

How can NRIs from the United States invest in Mutual Funds in India?

NRIs living in the United States can invest in Indian Mutual Funds, but there are some hassles that have to be overcome. You will require an NRE, NRO, or FCRN account in order to convert the foreign currency into Indian rupees, post which you can complete the KYC and begin investing in Indian Mutual Funds.

What are the types of ETFs available for investment?

Exchange-Traded Funds or ETFs are an investment tool that tracks particular securities like Equity, Commodity, Bonds, etc. ETFs are available for many categories from which one can choose from. These are listed on Stock Exchanges (NSE & BSE) hence there is ample liquidity and one can easily buy and sell these at their desired price during market hours. Some ETFs available for investment in Indian markets are Equity ETFs, Debt ETFs, etc.

What is Mirae Asset FANG Plus ETF?

The Mirae Asset NYSE FANG Plus ETF Fund is a good option for Investors who want foreign exposure. The Equity allocation is very concentrated to just 10 stocks which makes this ETF very volatile and risky. This ETF consists of the top 10 stocks in their respective sectors mostly TECH, like Amazon, Netflix. Facebook, etc. Hence Investors with high-risk tolerance and a long time period should consider this fund.

What are the charges in an ETF?

ETFs are investment instruments that are listed on stock exchanges that offer investors to get exposure to a variety of asset classes. ETFs can be of different types tracking a particular asset class like Index, Commodity, and a particular sector. There are some changes in an ETF that include the Expense ratio and some other fixed charges charged by brokers, SEBI, etc.