by Ankita Lodh on 12 May 2025, 5 minutes min read
Exchange-Traded Funds (ETFs) have been among the common investment instruments in India currently. As Indian investors look for accessible, transparent, and low-cost ways to invest in the equities market, ETFs are becoming increasingly popular.
But what is an ETF, really? How do ETFs work, and why are they suitable for beginners? In this blog, we will break down all that you need to know about ETFs in India, from their types, benefits, risks, and taxes. If you are a beginner in investing or trading and want to learn more about ETFs, this article will make you understand why ETFs could be the perfect starting point.
ETF’s full form is Exchange-Traded Fund (ETF). An ETF is an investment vehicle which takes a basket of assets, stocks, bonds, or commodities. ETFs are listed on stock markets like individual stocks and can be bought & sold like shares as well.
Most of the Indian ETFs are designed to mirror the performance of a single market index (e.g., Nifty 50 or Sensex), a commodity (e.g., gold), or a combination of assets (e.g., government bonds). ETFs are liquid because they can be traded at any time during trading hours. This is a major advantage for those who would prefer to react quickly to market movement.
The most common types of ETFs available in India include Equity ETFs, Gold ETFs, International ETFs, and Sector/Thematic ETFs.
Though both mutual funds and ETFs offer diversification, the latter has a certain advantage of trading on an exchange in real time. ETFs are less costly in terms of expense ratios and also more transparent in holdings.
Unlike mutual funds, which are bought and sold just at the end of the day, ETFs are available for sale and purchase during the trading day at market prices.
Fund Providers: Asset management companies (AMCs) create ETFs by building a portfolio that mirrors a particular index or asset class.
Authorised Participants (APs): These are typically large financial institutions that help in creating or redeeming ETF units in large numbers, maintaining the ETF’s price near its Net Asset Value (NAV).
Stock Exchanges: The ETFs are listed and traded on stock exchanges such as BSE and NSE, and investors can sell and buy units of an ETF just like a share.
Net Asset Value (NAV): This is the value per unit of the ETF’s underlying assets, calculated at the end of each trading day.
Market Price: The price at which units of an ETF are bought and sold on the exchange. Ideally, the market price is close to the NAV but fluctuates depending on demand and supply.
With an ETF, you have exposure to a large portfolio of securities, reducing the risk of investing in single stocks.
Most ETFs are passively managed, which means lower management fees compared to actively managed mutual funds. This helps improve your overall returns in the long run.
ETFs can be bought and sold anytime during market hours, providing flexibility and quick access to your funds.
ETFs tend to be more tax-effective than mutual funds because of their special structure, which reduces capital gains distributions.
Market Risk: An ETF’s price follows the same behaviour as that of its underlying securities. Should the market or underlying index decrease in value, then so would the ETF value.
Tracking Error: This is the variation between the performance of the ETF and the underlying index. Tracking error may be caused by management fees, lack of liquidity, or incomplete replication of the index.
Liquidity Risk: Although most major ETFs are very liquid, other specialised or sectoral ETFs might not have as high trading volumes, thus showing wider bid-ask spreads and an inability to purchase or sell units at desired prices.
Tax on Dividend Income
Dividends received on ETFs go into your total income and get taxed according to your applicable income tax slab. This means that the rate at which you will be taxed for dividends would be according to your overall annual income and the tax bracket selected. No additional tax of dividend distribution tax (DDT) on ETF dividends; the investor would be charged tax on this income.
Capital Gains Tax
| ETF Type | Short-Term Capital Gains | Long-Term Capital Gains (from July 2024) |
| Equity ETFs | Before July 23, 2024: 15% On or after July 23, 2024: 20% | Before July 23, 2024: 10% on gains exceeding Rs 1.25 lakh On or after July 23, 2024: 12.5% on gains exceeding Rs 1.25 lakh |
| Gold/International | As per income tax slab (<36 months) | 12.5% (no indexation) |
| Debt ETFs | As per income tax slab (<36 months) | 20% (with indexation) |
ETFs in India are an investor-friendly investment product, with the best of stocks and mutual funds. They provide diversification, low expense, transparency, and liquidity, which makes them suitable for new investors who wish to accumulate wealth over time without the hassles of stock selection or the high cost of mutual funds.
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