🧺 Mutual funds, index funds and ETFs: SIPs, direct plans and costs

🎯 In 30 seconds: A mutual fund pools money from many investors and a professional manager invests it under rules set by SEBI. You own units, and each unit's value, the NAV, is worked out once a day. An index fund simply copies an index such as the Nifty 50. An ETF does the same but trades on NSE and BSE like a share, so you need a demat account and its price can drift from its NAV. Every fund charges a yearly expense ratio, capped by SEBI, and a "direct" plan of the same fund costs less than a "regular" plan because no distributor commission is paid from it. Small differences in cost add up to lakhs over decades. A SIP is not a product, just a way of investing a fixed amount every month.

The basic idea: a shared tiffin

Imagine twenty friends in a hostel who each chip in ₹500 a week so one of them, the best cook, can buy ingredients in bulk and make lunch for everyone. Each friend gets a share of the food in proportion to what they paid. Nobody has to shop or cook, and buying in bulk is cheaper. The cook gets a small fee. That is a mutual fund: pooled money, one manager, costs shared, and each person's slice in proportion to their money.

In India, a mutual fund is set up as a trust, and an asset management company (AMC), often called the fund house, runs its schemes. SEBI regulates them under the SEBI (Mutual Funds) Regulations, 2026, which replaced the 1996 regulations. AMFI, the Association of Mutual Funds in India, is the industry body. It publishes every scheme's NAV each day and runs investor education.

• Units and NAV. When you invest, you buy units. The net asset value (NAV) per unit is the value of everything the scheme owns, minus its expenses and liabilities, divided by the units outstanding. Open-ended funds calculate it once each business day.
• Open-ended. Most schemes let you invest or redeem on any business day, directly with the fund house, at that day's NAV.
• No entry load. SEBI abolished entry loads. You do not pay a fee to get in. Some schemes charge an exit load if you redeem within a set period, explained below.

SEBI's scheme categories

To stop fund houses from launching a dozen look-alike schemes with confusing names, SEBI fixes the categories and what each must hold. The latest version is SEBI's circular of 26 February 2026 on categorisation and rationalisation of mutual fund schemes. Schemes are grouped broadly into equity, debt, hybrid, life cycle funds and "other" schemes (which include fund of funds and passive schemes such as index funds and ETFs). The equity rules you will meet most:

"Large cap", "mid cap" and "small cap" have fixed meanings here, based on a company's rank by full market capitalisation. AMFI publishes the official list every six months. Growth vs value, and why company size matters gives the cut-offs.

Every scheme also carries a riskometer, a dial with six levels from "Low" to "Very High" risk, printed on its documents. Almost every equity fund sits at "Very High". That is accurate: shares can fall 30% or more in a bad year, whoever is managing them.

Index funds and ETFs: copying the index

An actively managed fund has a manager who picks shares, trying to beat a benchmark. A passive fund does not pick. It holds the shares of an index in the same proportions as the index, and aims to match its return minus costs.

There are two passive wrappers:

For a beginner putting in a fixed sum each month, an index fund is usually simpler: no demat, no spread, no need to place orders. ETFs suit people who already have a demat account and want to buy at a chosen moment, or who want an exposure that is only available as an ETF.

How ETFs work behind the scenes

When you buy an ETF on NSE, you buy units from another investor or a market maker. The fund house is not involved. That is why an ETF's price can differ from its NAV: it is set by supply and demand on the exchange.

Two mechanisms keep the gap small.

• Market makers. Under SEBI's 2022 rules for passive funds, each ETF must have at least two market makers. They post buy and sell quotes on the exchange so there is someone to trade with.
• Creation and redemption. Market makers can deal directly with the fund house in large blocks called creation units. If the ETF trades above its NAV, they deliver a basket of the index shares (or cash) to the fund house, receive new units and sell them on the exchange, which pushes the price back down. If it trades below NAV, they do the reverse. Other investors can deal directly with the fund house only for amounts above ₹25 crore, so ordinary investors use the exchange.

In a busy ETF that tracks the Nifty 50, this works well and the price stays very close to NAV. In a small ETF tracking a niche index, there may be few trades, wide spreads and a noticeable premium or discount. NSE's ETF market watch shows each ETF's traded price beside its latest NAV, so you can compare before you place an order.

What funds cost: the expense ratio and more

The expense ratio is the yearly fee a scheme takes from its assets to pay the fund house, the custodian, the registrar, distributors and other costs. You never get a bill. It is deducted a little every day, and the NAV you see is already net of it.

SEBI caps it. Under the 2026 regulations, the cap is set on a base expense ratio, which excludes statutory levies such as GST and is separate from brokerage the fund pays when it trades. The limits as of October 2026:

These are ceilings. Many index funds and ETFs charge far less than 0.90%. Each scheme's current expense ratio is on the fund house's website and in its monthly factsheet.

Does a percentage point matter? Here is ₹10 lakh invested for 20 years, assuming the investments earn 11% a year before costs. The returns are hypothetical, not a forecast. Only the cost changes.

Other costs to know:

• Exit load. A charge, as a percentage of NAV, if you redeem before a set period. It is meant to discourage short-term trading. Each scheme's exit load is in its scheme information document (SID) and key information memorandum (KIM). Many index funds and ETFs have none, but check.
• Trading costs inside the fund. When the manager buys and sells, the fund pays brokerage. SEBI allows this to be charged on top of the base expense ratio, within limits. A fund with high portfolio turnover costs more than its headline ratio suggests.
• ETF trading costs. Buying an ETF on the exchange adds brokerage, STT, exchange charges, stamp duty and GST, and the spread. See What trading really costs in India.
• Taxes. Gains on fund units are taxed when you redeem. Rules differ by fund type and holding period; see Taxes for traders and investors.

Direct plans and regular plans

Since 1 January 2013, SEBI has required every scheme to offer a direct plan alongside the regular plan. Both are the same scheme: same portfolio, same manager. The difference is who you bought through.

• Regular plan: bought through a distributor (a bank, a mutual fund distributor, some apps). The distributor is paid a commission from the scheme's expenses, so the expense ratio is higher.
• Direct plan: bought directly from the fund house or through a SEBI-registered investment adviser. No commission is paid from it, so its expense ratio is lower and its NAV grows slightly faster. It has its own separate NAV.

The size of the gap varies by scheme, so compare the two expense ratios in the fund's factsheet, then use the chart above to see what that difference does over 20 years. A regular plan can still be worth it if your distributor gives you real help, such as keeping you invested during a crash. Just know what you are paying. If you use an investment adviser, check their SEBI registration; advisers charge you a fee directly instead of taking commission.

SIPs: investing the same amount every month

A systematic investment plan (SIP) is an instruction to invest a fixed amount in a scheme at a set interval, usually monthly, by auto-debit from your bank. It is not a separate product. It is a habit with automation.

Because the amount is fixed, you buy more units when the NAV is low and fewer when it is high. Here is ₹5,000 a month for four months in a volatile fund:

Your average cost is ₹20,000 / 550 = ₹36.36 a unit, lower than the average NAV of ₹38.75. At the month-4 NAV of ₹40, your 550 units are worth ₹22,000, a gain of 10%, even though the NAV is 20% below where you started. That effect is often called rupee cost averaging.

Be clear about what a SIP does not do. It does not make a bad fund good, it does not protect you from a long fall, and in a market that rises steadily, a single lump sum invested at the start ends up ahead, because more of the money is invested for longer. The real strength of a SIP is behaviour: it keeps you investing through bad months when most people stop. SEBI describes it as a way to "invest as you earn".

Tracking error: how closely an index fund follows its index

An index fund will never match its index exactly. It pays expenses, holds a little cash for redemptions, and buys and sells when the index changes. Two measures show how close it gets.

• Tracking difference: the fund's return minus the index's return over a period. If the Nifty 50 total return index made 12.0% in a year and the fund made 11.7%, the tracking difference is minus 0.3%. Most of that is usually the expense ratio.
• Tracking error: how much that gap wobbles from day to day, measured as a standard deviation. A low number means the fund follows the index closely day by day.

Under SEBI's 2022 passive fund rules, equity index funds and ETFs must keep tracking error within 2% based on one year of data, and must publish it daily. Compare tracking difference and tracking error between funds that follow the same index. With two Nifty 50 index funds, the one with the smaller gap over several years has done its job better.

Sectoral, thematic and small-cap funds

Broad index funds spread your money across many companies and sectors. Sectoral and thematic funds do the opposite. A sectoral fund must keep at least 80% in one sector, such as banks or technology. A thematic fund does the same for a theme, such as manufacturing or consumption.

• Concentration risk. If that sector has a bad few years, there is nowhere to hide.
• Timing risk. New themes tend to launch after a sector has already done well, when it is easy to sell. Investors who arrive then often buy near the top.
• Overlap. Many investors hold three or four "different" funds that own the same top twenty companies. Check the portfolios in the factsheets.

Small-cap funds carry a different risk: liquidity. Small companies trade far less, so a fund that must sell a lot of them quickly, because investors are redeeming, can push their prices down as it sells. In practice small-cap funds can fall much harder than the Nifty in a correction and take longer to recover. Before you invest, read the fund's factsheet for its portfolio, size and any liquidity disclosures, and assume a fall of 40% or more is possible.

A simple way to compare two funds

Say you are choosing between two hypothetical Nifty 50 index funds.

They own the same shares. Fund B's higher cost shows up almost one for one in its larger tracking difference. Over 20 years on ₹10 lakh, that half-point gap would be worth several lakh rupees. With passive funds, the cheapest one that tracks well is usually the right one. With active funds you also have to judge the manager, which is far harder and covered in A plan for a young person.

Try it

Go to the AMFI website and look up the NAV of any one Nifty 50 index fund in both its direct and regular plan. Note the two NAVs. Then open that fund house's website, find the latest factsheet, and write down for each plan: the expense ratio, the exit load, the fund size, and the tracking difference or tracking error it reports. Next, open NSE's ETF market watch, find two ETFs that track the Nifty 50 and note each one's last traded price, NAV and traded value. Work out each ETF's premium or discount to NAV as a percentage. Finally, in a spreadsheet, repeat the 20-year calculation in this chapter with the actual expense ratios you found.

Sources

• SEBI: SEBI (Mutual Funds) Regulations, 2026, last amended 10 October 2026 (base expense ratio limits, ETF and exit load definitions)
• SEBI circular (26 February 2026): Categorization and rationalization of mutual fund schemes
• SEBI: FAQs for mutual fund investors (direct plans, SIP, exit load, riskometer)
• AMFI: Direct plan
• AMFI: Net asset value
• Moneylife (2022): SEBI, tracking error of equity ETFs and index funds cannot exceed 2%
• Cafemutual (2022): SEBI passive fund measures (market makers, direct dealing above ₹25 crore)
• NSE: Exchange traded funds market watch