Exchange-Traded Funds, commonly known as ETFs, are one of the fastest-growing investment options in India. An ETF is a type of mutual fund that is listed and traded on stock exchanges, just like shares. It pools money from many investors and invests in a basket of securities such as stocks, gold, bonds, or market indices. The biggest difference between ETFs and traditional mutual funds is that ETFs can be bought and sold in real-time during market hours.
Over the past few years, investors in India especially young and tech-savvy investors have increasingly shifted towards ETFs due to low costs, transparency, and easy trading. But like all investment products, ETFs also come with their own pros and cons. Let’s understand how they work and whether they suit your investment needs.
How Do ETFs Work?
ETFs track a specific index or asset class. For example:
- Nifty 50 ETF tracks the Nifty 50 index
- Sensex ETF tracks the Sensex
- Gold ETF tracks the domestic gold price
- Debt ETF tracks government or corporate bonds
When you buy an ETF, you are investing in all the securities that the ETF holds. Since they are traded on the stock market, you need a Demat account and trading account to invest in ETFs. Their price fluctuates throughout the day based on demand, supply, and the value of underlying assets.
Advantages of Exchange-Traded Funds (ETFs)
1. Low Expense Ratio
One of the biggest reasons ETFs are popular in India is their low cost. Because most ETFs follow a passive investment strategy (simply tracking an index), the fund management cost is low. This helps investors earn better long-term returns compared to actively managed funds with higher fees.
2. High Liquidity
ETFs can be bought and sold at any time during market hours. This makes them more flexible than mutual funds, where you can only buy or redeem units once a day at the NAV. For investors who like quick entry and exit, ETFs offer strong liquidity—especially popular ones like Nifty and Gold ETFs.
3. Transparent and Simple
ETFs disclose their portfolio daily, so you always know exactly what you own.
Since they track an index, there is no confusion about fund strategy or stock selection. This transparency makes ETFs suitable for beginners.
4. Diversification at Low Cost
A single ETF gives you exposure to dozens or even hundreds of securities. For example, a Nifty 50 ETF gives you exposure to India’s top 50 companies. This diversification reduces risk and helps avoid overexposure to a single stock.
5. Lower Risk of Human Bias
ETFs are passively managed, so fund managers do not make frequent buy/sell decisions. This reduces the chances of human error or emotional decision-making impacting your returns.
6. Ideal for Long-Term Wealth Building
Their low cost, broad diversification, and market-linked growth make ETFs ideal for long-term investments, such as retirement planning or wealth creation.
Disadvantages of Exchange-Traded Funds (ETFs)
1. Requires Demat Account
Unlike mutual funds, which can be purchased directly through apps or platforms, ETFs require a Demat and trading account. For some new investors, this becomes an extra step and cost.
2. Liquidity Issue in Some ETFs
Not all ETFs are highly traded in India. While Nifty, Sensex, and Gold ETFs have good liquidity, several sectoral or thematic ETFs have low trading volume, making it difficult to buy or sell units at the right price.
3. Brokerage Charges
Since ETFs are traded like stocks, investors have to pay brokerage charges, transaction fees, and taxes each time they buy or sell. Frequent trading can increase costs.
4. Price Deviates from NAV
Mutual funds are bought at the NAV, but ETFs have a market price, which may be slightly higher or lower than the actual NAV. This difference—called the tracking error—can impact returns.
5. Limited Active Management
ETFs simply follow an index and cannot adjust during market crashes, economic changes, or sector-specific issues.
Actively managed mutual funds can outperform during such times because they have the flexibility to shift assets.
6. Not Suitable for Those Who Want SIP Flexibility
Although some platforms offer SIPs into ETFs, traditional mutual funds still provide smoother and more widely available SIP options. ETFs require investors to buy units manually at the market price.
Who Should Invest in ETFs?
ETFs are ideal for:
- Beginner investors who want simple and low-cost market exposure
- Long-term investors building wealth steadily
- Investors who prefer passive investing
- People who want to diversify their portfolio
- Those comfortable using a Demat account
They may not be suitable for investors looking for fund manager expertise, frequent portfolio adjustments, or highly managed strategies.
Conclusion
Exchange-Traded Funds (ETFs) are a smart, low-cost, and transparent way to invest in markets. Their biggest strength lies in simplicity and affordability, making them ideal for long-term Indian investors. However, limited liquidity in some ETFs, brokerage costs, and the need for a Demat account are factors to consider.
If you want steady index-based growth and long-term wealth creation, ETFs can be an excellent choice. But if you prefer active management or want SIP convenience, traditional mutual funds may still work better.