How to Invest in Exchange Traded Funds (ETFs) in India

Exchange Traded Funds (ETFs) are popular investment vehicles that offer a diversified approach to market participation. An ETF is a pooled investment fund holding assets like stocks, bonds, or commodities, with units traded on stock exchanges throughout the day, similar to individual stocks. These funds track the performance of a specific index, sector, or commodity, providing broad market exposure without directly owning the underlying securities. This article guides individuals on investing in ETFs within the Indian financial market.

Setting Up Your Investment Accounts

Before investing in the Indian ETF market, you must establish the necessary financial accounts and complete regulatory requirements. A Permanent Account Number (PAN) is mandatory for all financial transactions in India, serving as a unique identifier issued by the Indian Income Tax Department. It is essential for opening investment accounts, filing income tax returns, and tracking financial activities.

To hold ETFs, a Demat account is required. This account functions as an electronic repository for securities, dematerializing your holdings, and making transactions more efficient and secure. Concurrently, a trading account is necessary to place buy and sell orders on stock exchanges. Both accounts are typically opened through a Depository Participant (DP), often a stockbroker, and are linked to facilitate seamless transfers of securities and funds.

The Know Your Customer (KYC) process is a mandatory step to verify an investor’s identity and address. This involves submitting documents such as identity proof (e.g., Aadhaar card, passport) and address proof (e.g., utility bills, driving license). Completing KYC is a regulatory requirement that helps prevent financial fraud and ensures legitimate participation in the market. Finally, linking a bank account to your trading account is essential for transferring funds for investments and receiving payouts from sales or dividends.

Identifying Suitable ETFs

Selecting the right ETF involves understanding the various categories available in the Indian market and conducting thorough research. ETFs in India include:

Index ETFs: Track broad market indices like the Nifty 50 or Sensex, providing exposure to leading companies.
Sector-specific ETFs: Focus on particular industries, such as banking, IT, or pharmaceuticals, allowing investors to target growth in specific segments.
Commodity ETFs: Predominantly Gold ETFs, allowing investment in physical gold without storage complexities.
Debt ETFs: Invest in fixed-income instruments like government and corporate bonds, offering stable returns with lower risk than equity funds.

When researching ETFs, examine their expense ratio, the annual fee charged by the fund house for management. A lower ratio can significantly impact long-term returns. Tracking error measures how closely an ETF’s performance mirrors its underlying index; a lower tracking error indicates better replication. Liquidity, indicated by trading volume, is another important factor, as higher liquidity ensures easier buying and selling without significant price impact. Information for research is available on fund house websites, financial news portals, and stock exchange websites like NSE and BSE. Aligning ETF selection with personal financial goals, risk tolerance, and investment horizon is important to ensure the chosen ETF fits your broader investment strategy.

Placing Your ETF Orders

After completing preparatory steps and identifying a suitable ETF, execute the trade through your broker’s online trading platform. Log into your account; this platform serves as your gateway to the stock exchange.

Ensure sufficient funds are available in your trading account before placing an order. Funds are typically transferred from your linked bank account through digital payment methods. After funding, search for your chosen ETF using its ticker symbol or full name.

When placing a buy order, specify the quantity of ETF units. You can choose a “market order,” which executes immediately at the current best price, or a “limit order,” which allows you to set a maximum purchase price. A limit order executes only if the ETF’s price reaches or falls below your specified limit. For selling ETFs, select the ETF, specify the quantity, choose an order type, and confirm the transaction. After an order is placed, the trade undergoes a settlement process, typically a T+1 cycle in India. This means shares are credited to your Demat account or funds to your trading account one business day after the transaction.

Navigating Investment Costs and Taxes

Understanding the costs and tax implications of ETF investments in India is important for managing overall returns.

Costs incurred during the investment process include:

Brokerage charges: Fees levied by brokers for facilitating transactions, varying by broker and trade volume.
Expense ratio: An annual recurring fee charged by the fund house for managing the ETF, deducted directly from its assets.
Securities Transaction Tax (STT): A direct tax levied on the value of securities transactions executed on a stock exchange.
Other charges: May include stamp duty, which is a state-level tax on transactions, and transaction charges imposed by exchanges. Goods and Services Tax (GST) is also applicable on brokerage and other service charges, typically at 18%.

Capital gains from ETFs are categorized into Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG), with different holding periods and tax rates based on the ETF type. For equity-oriented ETFs, gains held for 12 months or less are STCG, taxed at 20% (Section 111A). If held for more than 12 months, gains are LTCG, with amounts exceeding ₹1 lakh taxed at 10% without indexation benefits (Section 112A). For debt-oriented, gold, and international ETFs, STCG (holdings less than 36 months) are taxed at the investor’s income tax slab rate. LTCG (holdings of 36 months or more) are taxed at 20% with indexation benefits. Dividend income from ETFs is added to the investor’s total income and taxed according to their applicable income tax slab rate. Investors must report all gains and income when filing annual income tax returns.