ETFsETF
Index funds that trade on the exchange like a stock — so price and NAV can drift apart, and you need a demat account and a buyer.
Why you care
An ETF is an index fund you buy and sell on the stock exchange, like a share, through a demat account. That gives it an even lower expense ratio, but it adds catches an index fund doesn't have. You need a buyer on the other side, and the price you trade at can drift above or below the fund's actual NAV.
Run the numbers
An ETF's true value (its NAV) is ₹250, but at the moment you place a market order, thin trading means the best available price is ₹252 (illustrative). You've paid a ₹2 premium — an invisible cost that never shows up in the TER. On an illiquid ETF, that gap can dwarf the fee you saved.
Where this goes
Like any passive vehicle, an ETF lives or dies on how faithfully it copies its index, which is its tracking error. It's the exchange-traded twin of the index fund — same underlying bet, different wrapper, and the wrapper's plumbing (demat, liquidity, price-vs-NAV) is where the real differences hide.
Why you care
An ETF (exchange-traded fund) holds an index like an index fund does, but its units trade on the stock exchange throughout the day. You buy and sell them at live market prices through a demat and trading account rather than at the day's single NAV. The appeal is cost: ETFs often carry an even lower expense ratio than the equivalent index fund. The complications are all in the plumbing.
Three catches matter. First, you need a demat account and you pay brokerage on each trade, so an ETF is clumsier for a small monthly SIP than a plain index fund. Second, and most important, an ETF's market price is set by supply and demand on the exchange, while its underlying value (the NAV, or the live "iNAV") is set by its holdings. Those two can diverge: on a thinly traded ETF you might buy at a premium to NAV or be forced to sell at a discount. That gap is a real cost that never appears in the TER. Third, liquidity varies enormously by ETF; the popular Nifty and gold ETFs trade tightly, while niche ones can have wide spreads. For most retail investors doing regular SIPs, an index fund is simpler; ETFs suit those comfortable trading and watching the price-versus-NAV gap.
Run the numbers
You want to buy an ETF whose NAV (fair value) is ₹250 (illustrative):
- On a liquid ETF, the market price sits within a paisa or two of ₹250, and you effectively trade at fair value.
- On an illiquid one, the best offer might be ₹252. You pay a ₹2 (0.8%) premium to get in, and you may face a similar discount trying to get out.
That round-trip gap can easily exceed a full year of the fee you saved by choosing the ETF over an index fund. The saved TER was visible; the price-versus-NAV cost was not, which is exactly why it catches people. The defence is simple: only trade liquid ETFs, use limit orders, and check the iNAV before you buy.
Where this goes
An ETF is judged on the same thing as any passive fund: its tracking error, how tightly it hugs the index it promises to copy. It's the on-exchange sibling of the index fund. Choosing between them is really a choice of wrapper: the index fund for simplicity and automatic SIPs. The ETF is for the lowest fee if you're willing to manage demat, liquidity, and the price-versus-NAV gap yourself.