Dos and don't of investing in exchange traded funds (ETFs)

Personal finance
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I keep seeing investors make a few common mistakes when buying and selling ETFs. We just shared these dos and don’ts of investing in ETFs on social media.

Exchange traded funds (ETFs) have grown tremendously in the last 5 odd years. There are over 174 ETFs; you can easily build a low-cost, globally diversified portfolio just with ETFs. But before you buy and sell ETFs, you should know a few things.:thread: A thread

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1. Don’t buy and sell immediately at the open market.

The trading volumes of ETFs are low for the first 15–30 mins after the market opens. Due to illiquidity, there can be sharp price moves. So, it’s best to avoid buying and selling at market opening.

2. Always use limit orders.

Though ETFs have grown, most of them have very low volumes. Most of the volume is concentrated in the popular ETFs. If you place a market order, your order may be executed at prices far away from the last traded price. So, always use limit orders.

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To put it another way, if you place a market order, the impact cost or the (money lost due to wide bid and ask prices) can be high. You lose what you save in the expense ratio of the ETF to impact costs.

Read about impact costs here:

3. Trade carefully during volatile markets.

During volatile market phases, ETFs can often trade at large premiums & discounts for a variety of reasons. For example, here’s how some Nifty 50 ETFs performed during COVID. You can see big differences compared to Nifty (black line).

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So when you buy and sell ETFs, make sure the price is as close to the iNAV as possible. The good thing is you can check iNAVs directly on Kite. There are times when the iNAV may be incorrect due to delayed updates. So it’s good to double-check it on the respective AMC websites.

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5. Be careful of illiquid ETFs.

As we mentioned earlier, not all ETFs trade regularly. So if you are investing in an ETF, don’t just check the volume of a day; check the historical volumes as well. You can see this quickly on the volume chart on Kite.

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6. Use ETF SIPs.

If you invest in ETFs regularly, you can create a SIP, just like with mutual funds. You can also create an e-Mandate to transfer funds to your trading account automatically for the SIPs.

Here’s how to create an ETF SIP:

To learn more about what you should remember when investing in ETFs, check out this
Zerodha Varsity chapter:

  1. Trading symbols of ETFs can be confusing. We’ve categorized all Indian ETFs based on the asset class, style, and themes. If you have any questions about investing in ETFs, you can ask us here.
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Thanks @Bhuvan
as always informative and to the point article.

  1. can you touch upon current tax treatment as per ETF categories like Equity, Debt, Gold (Silver), International equity.
    The information available is quite confusing so it would be nice if you can thro some light on it.

My understanding was ETF creating AMC (owner) is supposed to take care of both of these scenarios by a. dynamically creating/destroying units b. stepping in during volatile markets. Shouldn’t there be penalty to ETF owner AMC, if AMC cant handle these scenarios ?

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Hey @Bhuvan , shouldn’t you be giving steps on how to send ETF units to AMC for redemption incase of illiquidity

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@Bhuvan can you list some ETF equal to bharat bond, which gives fixed interest rate and low risk as bank FD

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You can sell the units directly to the AMC in the following cases:

Investors, other than Authorised Participants, can sell units in less than Creation Unit
Size of the Scheme directly to the Mutual Fund without any exit load in the following
cases:
• if the traded price of the ETF units is at a discount of more than 3% to the NAV for
continuous 30 days; or
• if discount of bid price to applicable NAV is more than 3% over a period of 7
consecutive trading days; or
• if no quotes are available on exchange for 3 consecutive trading days; or
• when the total bid size on the exchange(s) is less than half of creation unit size daily,
averaged over a period of 7 consecutive trading days.
Under these circumstances, investors, as specified above, can redeem units of the
Scheme directly with the fund house without any exit load. — ICICI

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Basically, all target maturity funds and ETFs. Almost all AMCs have these offerings, you can check for an ETF or a fund with a maturity and portfolio that suits you. If you see a fund or an ETF with a year in the name, it’s a target maturity fund. There are various types that are g-sec only, g-sec+SDL or PSU bonds. So you can pick and choose what works for you.

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Taxation is the same as mutual funds. Please see this post:

What you are referring to is market making. For market makers to make markets or provide liquidity, there has to be enough demand, which isn’t the case with a lot of ETFs. In some cases, there are other issues that market makers could face like funding constraints, regulatory restrictions, volatility etc. Having said that, in most of the popular ETFs, liquidity is fairly ok for small investors.

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Can NIFTYBEES be purchased by pledging stocks/SGB’s ?

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This was answered earlier by @ShubhS9

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