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Best ETFs in India: Invest in one most innovative funds of the time

While traditional mutual funds offer advantages of portfolio diversification, low-cost professional management, and liquidity, ETFs have taken the mutual fund investment to the next level with more liquidity, transparency, & flexibility, and better taxability.

But what are ETFs? Let's explore the following article and get a better understanding of ETFs and see what makes them better than traditional mutual funds.

What is an ETF?

An ETF, also known as an Exchange-traded fund, is the one that trades in real-time on the stock exchange, just like a stock. Thes funds can be passively managed or actively managed. Passively managed funds don't try to outperform their underlying index but instead replicate its performance. Passively managed ETFs don't outperform their underlying index and only imitate its performance, whereas actively managed ETFs try to outperform a benchmark index.

ETFs offer diversified exposure to the market through a single investment. These funds offer lower costs, more transparency, and better tax efficiency than mutual funds.

The investors can buy and sell the ETF units through a registered broker of a recognized stock exchange. The ETF units are the units of a portfolio which is a collection of financial investments like stocks, bonds, and others that tracks the earnings and return of its underlying index. Investors can buy as many units from the exchange based on their investment needs.

Best ETFs in 2022 in India

The following table exhibits some of the well-known ETFs in India:

Scheme Name
Direct plan - Growth option
AUM(Rs. crores)
Axis AAA Bond Plus SDL ETF 2026 Maturity Fund Of Fund167.12
ICICI Pru Nifty Low Vol 30 ETF FOF468.88
Bharat Bond ETF FOF815.98
Mirae Asset NIFTY India Manufacturing ETF38.35
Axis Equity ETFs FOF17.72

Who should invest in an ETF? 

Since ETFs offer built-in diversification benefits and don't require large amounts of investment money to invest in a range of sticks, they are a good way to get started with investment. With ETFs, investors can enjoy dual benefits. They can trade like stocks and also enjoy a diversified portfolio. These funds are a better option for new investors who want to experience the equity market for the long term and with less risk. ETFs are also suitable for investors who have surplus cash but are confused about how to invest the money. Such investors can invest in an ETF for the time being and enjoy diversification benefits while earning some return till their money gets suitably deployed.

Taxation of gains from ETF

Since the ETFs invest majorly in equity and related instruments, the taxation of ETFs is similar to that of equity. Long-term capital gains of over Rs 1 lakh from a holding period of more than one year are taxed at 10%. The capital gains of less than Rs 1 lakh are tax-free. The short-term capital gains earned from the holding period of less than one year get taxed at 15% along with applicable surcharge and other cesses.

Gold, debt, and other ETFs get taxed in a similar manner. If the investor redeems the units before three years, the capital gains are considered short-term gains. These gains are added to investors' annual incomes and taxed as per their income tax slab rate. The long-term capital gains from the holding period of more than three years will get taxed at 20% with indexation benefits.

Risks Associated with ETF

ETFs do come with various risks that investors should be aware of before investing. 

  • Liquidity risk: Liquidity means the ability to turn an investment into ready cash without incurring a loss. Liquidity risks arise when ETFs have lower liquidity. As a result, investors can incur higher trading costs or face difficulty in buying or selling the ETF units.
  • Market Risk: Like all market-related investments, ETFs are also susceptible to market risk. Investors can counter these risks by diversifying their investments across various markets and sectors. 
  • Bid-ask spread risk: Bid-ask spread is the difference between the bid price (the highest price a buyer is willing to pay for a unit) and the ask price (the lowest price a seller is willing to take to sell that unit. When a bid-ask spread is wide, it becomes difficult to trade in and out at a fair price.
  • Tracking Error: Index ETFs track a particular index as its underlying. The returns generated by the ETF can be lower or higher than that of its target Index.

Advantages of investing in ETF

Here are some of the benefits offered by ETFs to investors. 

  • Low cost: As such both traditional funds and ETFs levy charges for fund management and operation of the scheme. However, the expenses in ETFs are much lower in comparison to open-ended mutual funds. ETFs also protect the interest in the long term from the inflows and outflows of the short-term investment.
  • Portfolio Diversification: By investing in one ETF product, you get exposure to the market through a basket of securities. With ETFs, you invest in various sectors, styles, industries, and country-specific funds. Such a wide choice of diversification options helps an investor manage the risk in a better way. 
  • Convenience in Investing: With ETFs, you have the convenience of real-time trading during market hours. You can buy or sell the units at any given time during these hours, which is not the case with traditional mutual funds, where you need to wait till the market closes if you want to know the price at which the trading is carried out. If you want to invest in an ETF, you can call a registered broker and book your units, and a similar process is applicable for redeeming units partially or fully. 
  • Arbitrage investing opportunity: ETFs are quite easy to buy and sell. It allows investors to manage their portfolios actively and reduce the risk. Let's understand through an example. Suppose an investor has high exposure to banking stocks and wants to hedge, so they can short the banking and similar sector ETFs and create a new portfolio using underlying ETFs. 
  • Transparency: ETFs are known for the level of transparency they offer to investors. The indicative NAVs of stock are available in real-time, and so is the basket of securities of the portfolio. It helps the investors know what they are investing in at what price, thus supporting them in making the right decision.

Why invest in an ETF?

ETFs are cost-efficient, transparent, and tax-efficient ways to get exposure to the stock market. Since these funds are listed in exchange and traded like stocks, they are highly liquid and offer a real-time settlement. ETFs are comparatively less risky as they replicate a stock index, offering diversification much better than the option of selecting and investing in a few stocks.

With ETFs, you get a lot of flexibility in the trading, like selling short or buying on margins. Another benefit of ETFs is that you get to invest in multiple securities within one product. ETFs diversify and complement any portfolio while providing exposure to various sectors and geographic regions.

However, note that ETFs are not suitable for every investor. These funds are a better option for new investors who want to experience the benefits of the equity market for the long term and with less risk. Before investing in ETFs, it's important to have a good understanding of the financial market as it requires a hands-on investment style to manage your ETF investments.

Conclusion 

ETFs are an innovative investment tool that can help you gain exposure to virtually any market or industry sector. But it's important to note that all ETFs are not equal. Every ETF comes with different investment objectives & strategies, risks, and costs that you should investigate before investing. Also, consider your financial goals and risk appetite, and plan your approach to how & when to act to reap the benefits of passive investing in the long term.

FAQs

Want to get more clarity about ETFs? Explore the following FAQ section to know more about these funds.

  1. What cost do investors incur in buying and selling an ETF?
    • Ans: ETFs are listed & traded on the exchange. So to carry out its operation, investors incur various costs in the form of brokerages, management fees & taxes.
  2. What is the minimum investment amount for an ETF?
    • Ans: The minimum investment in the ETF is equivalent to the amount of share (unit) to be purchased.
  3. How are ETF and mutual funds different?
    • Ans: The primary difference between ETFs and mutual funds is the way both are traded. In an ETF, shares can be bought and sold anytime when the exchange is open. However, mutual funds trade only once a day when the market closes. With an ETF, investors also benefit from various trading strategies such as shorting, using margin, etc., which are not available in mutual funds.
  4. How to buy an ETF?
    • Ans: ETFs are purchased similarly to stocks online or through investment advisors and registered brokers. 
  5. What is the best route to invest in ETFs?
    • Ans: You can invest in ETFs through a SIP and lump sum. However, SIP is more convenient as it brings efficiency through automated processes, allows you to adjust investment to the market conditions, and makes you stick with long-term goals.

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