I recently heard about exchange-traded funds (ETFs). How different are they from equity funds and how should one invest in them? – Ravi Gupta, Ghaziabad
An ETF is like a mutual fund that tracks an index, a commodity or a basket of assets, but trades like a stock on stock exchange. ETFs are similar to diversified equity funds, except that the shares in an ETF can be bought and sold throughout the day like stocks on a stock exchange through a broker-dealer.
The other difference between ETFs and diversified equity funds is that unlike traditional mutual funds, ETFs are not bought and sold at net asset value (NAV), but are traded on the stock exchange at a market determined price that is close to the NAV of the fund.
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There are a few factors to consider before investing in ETFs: expense ratio of the ETF, tracking error and liquidity. Once you know of these parameters, look for ETFs that closely track the underlying index they mirror with minimal tracking error. Among these, choose funds with lower expense ratios. An equally important factor to check is liquidity—the ease with which you can sell an ETF and redeem your investment. As ETFs can be sold through a stock exchange, look for liquidity through the trading volume of the ETF before investing.
