What is an exchange-traded fund and why are ETFs popular?

Key Takeaways
 

• Low fees compared to mutual funds
   
• Trade anytime during market hours
   
• Diversify instantly with one purchase
   
• Daily disclosure of holdings
   
• Tax-efficient structure

An exchange-traded fund (ETF) is an investment fund that holds a diversified portfolio of assets like stocks, bonds, or commodities and trades on stock exchanges just like individual stocks. ETFs combine the diversification benefits of mutual funds with the trading flexibility of stocks, allowing investors to buy or sell shares throughout market hours at current market prices.

For example, if you buy one unit of the Nifty 50 ETF for ₹150, you're essentially purchasing a tiny slice of all 50 companies in the Nifty index. Your investment moves up and down with the overall index performance, giving you instant diversification across India's largest companies through a single trade.

Meet Arun, a wealth management advisor, and his client Meera, a marketing executive exploring modern investment options. Throughout this blog, we'll follow their comprehensive discussion as Arun explains it to Meera on why ETFs have revolutionized investing for millions of investors worldwide.

What Are Exchange-Traded Funds: The Investment Innovation

Exchange-Traded Funds (ETFs) are investment baskets that trade like stocks, offering instant diversification and the ability to buy or sell at any time during market hours.

ETFs combine the advantages of mutual funds and stocks. They pool several assets, such as stocks or bonds, into a single fund, allowing investors to diversify without acquiring individual securities.  Unlike mutual funds, which are determined once a day, ETF values change throughout the day due to supply and demand.

Most ETFs track market indices passively, which results in modest expenses. When you buy an ETF, you are purchasing shares of the fund rather than individual assets, making it a flexible and cost-effective investment.

The table below compares key features of ETFs with traditional mutual funds and individual stocks, highlighting how ETFs offer a unique combination of flexibility, diversification, cost efficiency, and transparency for investors.

ETFs combine the best of mutual funds and stocks by offering easy trading, broad diversification, lower fees, and clear information, making them a smart, flexible choice for most investors.

Bonus Point: Don’t overlook tax implications, ETFs are generally tax-efficient, but short-term trading can trigger capital gains.

Types of ETFs: Diverse Investment Opportunities

Arun: "ETFs come in many varieties, covering nearly every asset class and strategy. You can invest in broad markets, specific sectors, bonds, commodities, or international markets, all through ETFs."
 

• Index ETFs are the most common and track broad indices like the Nifty 50, S&P BSE 500, or the S&P 500 internationally. They offer broad market exposure and are ideal for core portfolio holdings.
   
• Sector ETFs focus on specific industries such as banking, IT, or pharmaceuticals, allowing tactical allocation based on economic conditions.
   
• Bond ETFs provide fixed-income exposure with liquidity similar to stocks. You can choose government, corporate, or international bond ETFs for income and stability.
   
• Commodity ETFs offer exposure to precious metals like gold or silver and other commodities such as oil or agriculture, providing inflation protection and diversification without physical storage.
   
• International ETFs let Indian investors access foreign markets, developed and emerging, offering geographic diversification and currency exposure.
   

The table below summarizes the main types of ETFs, their investment focus, relative risk, typical expense ratios, examples, and ideal uses. This overview helps illustrate the wide range of opportunities ETFs provide to build diversified, cost-effective portfolios.

 

With so many ETF kinds available, you may diversify your portfolio across asset classes and regions.  ETFs have low expenses, strong liquidity, and transparency, making them ideal for achieving a variety of investing objectives.

Why ETFs Are Popular: Key Advantages Driving Adoption

ETFs are popular because they offer low costs, easy trading throughout the day, daily transparency, broad diversification, and tax efficiency. Investors save on fees compared to mutual funds, can trade anytime during market hours, and get clear visibility of holdings. By holding many assets in one fund, ETFs reduce risk while helping build wealth efficiently.

The table highlights the main advantages of ETFs over traditional mutual funds and individual stocks. It shows how these benefits translate into better cost savings, flexibility, and overall investment value for investors.

 

These advantages give investors more control over their money, lower fees, and better ways to manage taxes, reasons why ETFs have become so popular worldwide.

Bonus Tip: If you’re starting with a smaller budget, look into systematic investment plans (SIPs) or fractional shares. They make investing in ETFs more affordable and accessible.

Conclusion: 

ETFs combine the best features of mutual funds and stocks. They let you invest simply across many types of assets and markets, with low fees, easy trading, quick diversification, and regular updates. While there are some risks like trading costs and liquidity, ETFs remain a smart, flexible, and affordable choice for most investors who want more control and variety in their portfolios.

Frequently Asked Questions (FAQs)

Q1: How do ETF expense ratios compare to mutual funds?
Compared to actively managed mutual funds, which charge 1.5% to 2.5%, exchange-traded funds (ETFs) usually have expense ratios of 0.05% to 0.75%. Over extended investing periods, this cost advantage can compound dramatically and save thousands of rupees yearly.

Q2: Are ETFs more secure than stocks?

ETFs are less risky than individual stocks because they offer quick diversification over a wide range of underlying assets. They still entail market risk, though, and will drop if the underlying markets or industries do poorly.

Q3: Do ETFs pay dividends?
Yes, ETFs that hold dividend-paying stocks typically distribute dividends to shareholders, usually quarterly. The dividend yield depends on the underlying holdings' dividend payments.

Q4. Are dividends paid by ETFs?

Yes, shareholders usually receive dividend payments from ETFs that contain dividend-paying companies on a quarterly basis. The dividend payments from the underlying stocks determine the dividend yield.

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About the Author

LoansJagat Team

‘Simplify Finance for Everyone.’ This is the common goal of our team, as we try to explain any topic with relatable examples. From personal to business finance, managing EMIs to becoming debt-free, we do extensive research on each and every parameter, so you don’t have to. Scroll up and have a look at what 15+ years of experience in the BFSI sector looks like.