Exchange-Traded Funds Explained for Non-Finance People

Exchange-Traded Funds or ETFs are a distinct type of security that have features of mutual funds and shares. You can imagine it as the outcomes when shares and mutual funds have a baby together. Best of both worlds! ETFs are a basket of securities that trade on the market. You can easily buy a unit of ETFs, just like a share of a company. They track the performance and get returns of indexes like NIFTY 50 or Sensex.

ETFs are similar to a mutual fund but have significant differences in terms of trading, taxation and cost. For instance, if you invested in an open-ended mutual fund, you cannot trade it on the stock market. On other hand, you can trade ETFs on a share market. Another difference is in terms of tax. Redeeming a mutual fund is a cost to the fund manager because he needs to give back your money. For that, he needs to sell some of the positions to get the required liquidity. When you sell an ETF, it is to another buyer in the market. Hence no liquidation of the underlying assets!

Mutual fund managers also require a high management cost because they are required to generate active returns. ETFs are mainly passively managed, i.e. they will give you a return of the index not higher than that. Hence the higher management cost is eliminated.

Investing your money in ETFs is a wise choice, especially if you are looking to invest your money in a basket of stocks with a particular theme — Auto, IT, Banks or size — Large Cap, Mid Cap, Small Cap and even popularity — Sensex, Nifty50

It is also a good choice if you want to have the flexibility to exit your position anytime with no additional cost, unlike mutual funds. However, there are some disadvantages too. Just like in an index, it might be a risky investment during uncertainty in the market. Beware some ETFs contain stocks that are traded infrequently. Some of the ETFs that trade in India are HDFC Sensex ETF, UTI Gold ETF, Motilal Oswal NASDAQ 100 ETF. Remember, these are just examples and not suggestions! Good luck!

Concept: Shivangi Bhatia Editor: Minakshi Agrawal Todi

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