Understanding ETFs

Introduction

Remember when your uncle started bragging about his “ETF portfolio” at last year’s family wedding? While everyone nodded politely, most people had no clue what he was talking about. You probably thought it was just another fancy financial term that rich people throw around to sound smart. Well, turns out your uncle might actually be onto something good this time.

Exchange-Traded Funds, or ETFs as they’re commonly called, aren’t some complicated rocket science meant only for MBA graduates or stock market wizards. They’re actually pretty straightforward once you get past all the jargon. Think of this as your friendly neighborhood explanation – the kind you’d get from that one friend who actually knows about money stuff but doesn’t make you feel stupid for asking basic questions.

What Is an Exchange-Traded Fund (ETF)?

Let’s say you want to buy fruits for your family, but you can’t decide between apples, oranges, or bananas. Your local fruit vendor offers you a mixed bag with all three at a discount. That’s basically what an ETF does, except instead of fruits, you’re getting a mixed bag of different company shares.

When you buy the HDFC Sensex ETF, you’re not picking individual companies like Reliance or Tata Motors. Instead, you’re buying a tiny slice of all 30 companies that make up the Sensex. It’s like getting a mini portfolio without having to research each company individually or having enough money to buy expensive shares of every single one.

Your grandfather probably bought individual company shares back in his day, which meant he had to study each business carefully. These days, you can just buy the whole market basket and let someone else do the heavy lifting.

How ETFs Work

Picture this: You and nine friends want to invest in the stock market, but none of you has the Rs 50,000 needed to buy one share of MRF (yes, the tire company’s share really costs that much). So you all pool together Rs 5,000 each, buy one MRF share collectively, and split the ownership equally. Now each person owns 1/10th of that expensive share.

ETFs work exactly like this, except instead of 10 friends, there are thousands of investors, and instead of buying one company’s share, the fund manager buys shares of hundreds of companies. When the companies do well and their share prices go up, your ETF units become more valuable too. When they pay dividends, you get your proportional share of that money as well.

The best part? You can buy and sell these ETF units anytime during market hours, just like regular shares. No waiting for the next business day like with traditional mutual funds.

Types of ETFs

Just like how Mumbai local trains have different routes – Western, Central, and Harbour line – ETFs also come in different varieties:

Equity ETFs: These buy shares of companies. The Nippon India Nifty 50 ETF is like taking the main line train – it covers all the major stations (companies) without any fancy stops.

Bond ETFs: These invest in government and corporate bonds. Think of them as the slow passenger train – steady, predictable, but won’t give you the thrill of an express ride.

Gold ETFs: Remember how your grandmother used to buy gold during every festival? Gold ETFs let you do the same without worrying about making charges, storage, or purity. The HDFC Gold ETF is popular among people who want gold exposure minus the drama.

Sector ETFs: These focus on specific industries. If you believe IT companies will boom (which they often do), you can buy an IT ETF instead of trying to pick winners like TCS, Infosys, or Wipro individually.

Pros and Cons of ETFs

The Good Stuff:

ETFs are like that reliable friend who never lets you down. You don’t need to be a crorepati to start investing. With just Rs 500, you can own pieces of companies that would otherwise cost lakhs to buy individually. Your domestic help’s son can invest in the same blue-chip companies as a Bollywood celebrity.

The fees are much lower than regular mutual funds. While your bank might charge 2% annually for their mutual fund, most ETFs charge less than 0.5%. Over 20 years, this difference could pay for your child’s college admission fees.

You also know exactly what you’re buying. Unlike some mutual fund managers who keep changing their minds about which stocks to buy, ETFs are transparent. If you own a Nifty 50 ETF, you know you own the same 50 companies in the exact same proportion as the index.

The Not-So-Good Stuff:

ETFs aren’t perfect though. Unlike SIPs where money automatically gets deducted from your savings account every month, you need to manually buy ETF units. This means you might forget to invest some months, especially during festival seasons when you’re busy with celebrations.

Also, since ETFs simply copy an index, they’ll never beat the market. If the Sensex goes up 12%, your Sensex ETF will also go up around 12% (minus small fees). Some mutual fund managers might deliver 15% in a good year, but they might also give you 8% in a bad year. With ETFs, you get what the market gives – no more, no less.

How to Invest in ETFs

Getting started with ETFs is easier than booking tickets on IRCTC (and definitely less frustrating). You need a demat account with any broker. Most young investors these days use apps like Zerodha, Groww, or even their bank’s mobile app.

Once your account is ready:

1. Open your trading app during market hours (9:15 AM to 3:30 PM on weekdays)
2. Search for the ETF you want, like “SBI Nifty 50 ETF”
3. Check the current price (it changes throughout the day)
4. Decide how many units you want to buy
5. Place your order

The process is identical to buying shares of any company. The money gets deducted from your linked bank account, and the ETF units show up in your demat account within two days.

Popular ETFs

Among Indian investors, the SBI ETF Nifty 50 is like the Maruti Suzuki of ETFs – reliable, popular, and gets the job done without any fuss. It tracks India’s top 50 companies, so when these giants do well, you do well too.

For those who prefer gold over equity (especially during uncertain times), the SBI Gold ETF is quite popular. It’s much more convenient than buying physical gold from your local jeweler and definitely safer than storing gold bars under your mattress.

ETFs vs. Mutual Funds vs. Stocks

If buying individual stocks is like preparing a full thali at home – lots of research, time, and effort but potentially very rewarding – then mutual funds are like ordering from a good restaurant where the chef decides the menu. ETFs, meanwhile, are like going to a buffet where you can see exactly what’s available and serve yourself at wholesale prices.

Each has its place depending on how much time you want to spend, how much control you want, and what kind of returns you’re expecting.

FAQ

How do ETFs work for beginners?

Think of ETFs as ready-made investment baskets. You buy units of these baskets, which contain shares of many companies. When these companies do well, your units become more valuable. Start with broad market ETFs that track popular indices like Nifty 50.

What is the 3:5-10 rule for ETFs?

This is a simple rule financial planners use: keep money for expenses within 3 months in your savings account, money needed within 5 years in stable investments like bonds, and money you won’t need for 10+ years in growth investments like equity ETFs.

What is the 70/30 rule for ETFs?

Many investors put 70% of their money in equity ETFs (for growth) and 30% in bond ETFs (for stability). But this depends on your age – younger folks can take more risk with higher equity allocation.

How do you make money with an ETF?

You make money in two ways: when the companies in your ETF perform well and their share prices rise, your ETF units become more valuable. Also, when these companies pay dividends to shareholders, you receive your proportional share of those dividends.

Disclaimer : Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.