In the simplest terms, Exchange Traded Funds (ETFs) are funds that track indexes like the Nifty 50, Junior Nifty, Bank Index, Gold, etc. When you buy shares of an ETF, you are buying shares of a portfolio that tracks the yield and return of its native index. The main difference between ETFs and other types of index funds or Mutual Funds is that ETFs don’t try to outperform their corresponding index, but simply replicate its performance. They don’t try to beat the market, they try to be the market.
As the name implies, ETFs are traded on stock exchanges like any other stock, giving you instant liquidity. They can be designed to track a portfolio of anything: a stock index, commodities or bonds. The primary difference between an ETF and a Mutual Fund is that the ETF can be traded throughout the day. Whenever the quoted value of the ETF falls outside its portfolio value, arbitrageurs typically step in and correct the imbalance. This minimizes the deviation between the market price and the net asset value of ETF shares.
Passive ETFs like NIFTYBEES, BANKBEES, JUNIORBEES, etc. track the underlying index are re-balanced whenever the index is re-weighted. For an investor who is just looking to gain exposure to the broad market, ETFs provide a low-cost way of doing so.
Given various research that show that fund-managers are no better at beating the market than blind monkeys throwing darts, ETFs have gained favor with self-directed investors as a low-cost, buy and hold, long-term investment vehicle.