An exchange traded fund, or ETF, refers to a basket of securities that works like an index mutual fund apart from the fact that the form can be traded on a stock exchange just as a listed share.
Since ETFs can be bought and sold during the day, their price fluctuates throughout the trading day unlike mutual funds which have one closing price at the end of the day.
What are exchange traded funds?
ETFs are passive funds which replicate the returns of a market index they track. Since these funds track an index, the returns of these funds move in tandem with those of the underlying index.
Since these funds are passive and track an index, they have a lower expense ratio. These funds have a lower administrative cost i.e., around 0.20 percent against one percent yearly cost of some of the actively-managed mutual funds.
Why should an investor invest in an ETF?
One of the key advantages of ETFs is that investors get to experience the best of both the world via an ETF investment.
On one hand, an investor gets to experience the diversity of securities and at the same time, one can trade these instruments in the stock market on a real time basis.
Another advantage of ETFs is that these investments enable investors to enjoy the perks of passive investing. When an investor wants to tie the earnings of his investment to those of the broader index such as Nifty50 or a sectoral index such as Nifty IT then one of the most convenient and safe forms of investing is to opt for exchange traded funds.
ETFs and index funds
Index funds track benchmark index and are priced at the end of the trading day based on the NAV of underlying securities.
On the other hand, ETFs trade during the trading day and their price fluctuates during the trading day. To be able to trade in ETFs, investors need to have a demat account whereas no demat account is needed to invest in index funds.