What is an Exchange-Traded Fund (ETF)?
An ETF is a fund that comprises a group of stocks that are listed on an exchange and can be simply traded like any other listed security.
Typically, an ETF mirrors a particular index, which means the group of stocks in the ETF would be similar to those in the index that it is benchmarked to. So, for instance, an ETF mirroring the Sensex would have the same 30 stocks that the Sensex has.
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In other words, if one buys an ETF mirroring the Nifty, he’s indirectly buying all the stocks that are there in the Nifty without going through the trouble of buying each stock individually.
What are the benefits of investing through ETFs?
The biggest benefit is liquidity. Since an ETF is publicly listed and traded on a stock exchange, liquidity is not an issue. An investor can know the price of each unit of the ETF and take an informed decision.
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The price of the ETF is based on the net asset value of the underlying stocks. Second, the fund management fee of an ETF is much lower than that of a normal mutual fund scheme. So, investors save on that aspect as well while getting the benefit of a professional fund manager.
What is the difference between an ETF and an Index Fund?
While an index fund is also designed to mirror a particular index, there are some differences between an ETF and an index fund. First, an index fund is just like any other mutual fund wherein the net asset value (NAV) of the fund is based on the closing price of the underlying securities.
In the case of an ETF, however, the NAV is continuously linked to the current market price of the underlying stocks, which also makes it possible to buy or sell the ETF unit throughout the day just like an ordinary stock. But, since an ETF is traded like a stock, one needs a demat account to buy or sell an ETF whereas an index fund can be bought directly from an asset management company without having a demat account.
Are ETFs available only for stocks?
No. An ETF can be created for any kind of asset or security that has an index or a liquid market for the underlying securities of the ETF.
Globally, there are many ETFs on bonds, currencies and commodities as well. In India, gold ETFs are quite popular and have physical gold as the underlying security.