An exchange-traded fund (ETF) is a combination of share and mutual fund. Like a mutual fund in ETF money is pooled from different investors and invested in stocks comprising an index and traded on exchange like a stock. Most of the ETFs are passively managed and closely track an index. Hence they are passively managed, the expenses ratio is much lesser than mutual fund.
ETFs are most popular financial products with no exit load and instant liquidity. As most of the ETFs track an index, so they should not outperform or underperform from their index. An ETF is rebalanced when an index is rebalanced.
Why ETFs are so popular?You can invest in ETF with a fraction of the cost and get exposure to particular security, available in ETF.
For example:If you want to buy Nifty index then you have to buy all the fifty stocks present in Nifty, that is very costly. But you can buy one unit of ICICI prudential Nifty ETF and get exposure to the Nifty index.
You can get exposure of Real Estate Investment by investing in real estate ETFs with a small amount.
ETFs are mostly similar to Index mutual funds.
Hence, ETFs are passively-managed, it makes them most similar to index mutual funds. Within this similarity, both the index fund and the ETF will mimic the performance of an underlying index, such as the Nifty 50; Both are having extremely low expense ratios than to actively-managed funds, and they both can be prudent investment types for diversification and portfolio construction.
Difference between ETFs and Mutual Funds.1. Mutual funds are bought from fund houses and ETFs are traded on stock exchange like a stock.
2. Mutual fund have a NAV (Net Asset Value) which is decided at the end of the day, But an ETF has a real time price called iNAV (Indicative NAV).
3. Expense ratio of ETF is lower than the mutual fund and can sometimes lower than of index fund. However, ETFs can have higher trading costs. Some brokerage firms charge commissions for trading ETFs. If you trade ETFs frequently, the cost of the commissions could end up exceeding the savings on the lower expense ratio compared to the comparable mutual fund.
4. Mutual funds can be either passively-managed or actively-managed; whereas most of the ETFs are passively managed.