ETF vs Mutual Fund Liquidity Explained: Which Option Gives You Better Flexibility?

In June 2023, I bought 500 units of a Nifty IT-sector ETF not the most popular one, a smaller AMC’s version at around ₹42 a unit through Zerodha Kite, roughly ₹21,000 total. Five months later, when I wanted to exit, the best bid sitting on the order book was ₹40.20, nearly 4% below the ETF’s own indicative NAV that day, purely because the fund barely traded a few thousand units on an average session.

I assumed an ETF, being listed on the exchange and tradeable anytime the market was open, was automatically more liquid than a mutual fund. That assumption cost me real money the day I actually needed to sell, and it’s a mistake I’ve since seen other people make too, usually with the same reasoning: “it trades all day, so I can get out anytime.” The ETF vs mutual fund liquidity question isn’t as simple as “one trades all day and one doesn’t” it depends heavily on which specific ETF you’re holding, and almost nobody explains that part before you buy.

That gap is what HMA Wealth is trying to close here, since most comparisons of ETF vs mutual fund liquidity stop at the surface-level mechanics without getting into what actually happens when you try to exit a thinly traded fund.

What Does “Liquidity” Even Mean When You’re Comparing an ETF and a Mutual Fund?

Liquidity, in plain terms, is how easily and predictably you can convert an investment into cash at a fair price. It has two separate pieces that matter: whether you can sell at all, and whether the price you actually get is close to what the investment is genuinely worth.

ETFs (Exchange Traded Funds) trade continuously on NSE and BSE during market hours, the same way a stock does your buy or sell order gets matched against another investor’s order in the exchange’s order book. Mutual funds, at least the open-ended kind most people hold, work differently: you don’t trade with another investor, you transact directly with the fund house (AMC), and every purchase or redemption happens at that day’s closing NAV, not a live price. That structural difference is the entire root of the ETF vs mutual fund liquidity question one relies on other traders showing up, the other relies on the AMC’s standing obligation to you.

Why Doesn’t Being “Listed on an Exchange” Automatically Mean an ETF Is Liquid?

This is the part my IT-sector ETF taught me the hard way. Being listed just means an order book exists it doesn’t guarantee anyone’s actually placing meaningful orders in it.

A few things determine whether an ETF is genuinely liquid or just technically tradeable:

Popular ETFs tracking the Nifty 50, Sensex, or gold tend to have tight spreads and high volume, genuinely delivering on the “trade anytime” promise. Niche sectoral, thematic, or smaller-AMC ETFs, like the one I bought, often don’t and that gap between iNAV and what you can actually execute at is a real cost, not a theoretical one.

There’s actually a mechanism designed to prevent this gap from growing too large: large institutions called Authorised Participants (APs) can create or redeem ETF units directly with the AMC in bulk, in exchange for the underlying basket of securities, and they’re supposed to step in and arbitrage away big price-to-iNAV gaps for a profit. In theory, this keeps ETF prices tethered close to fair value. In practice, for a fund with low daily volume and a small AUM, the arbitrage isn’t always worth an AP’s time on any given day, and the gap I ran into simply sat there until enough retail sellers like me showed up to move the price.

How Does Mutual Fund Redemption Actually Work, and Why Is It More Predictable?

Open-ended mutual funds carry a structural guarantee that most ETFs don’t: the AMC is obligated to honour your redemption request at that day’s closing NAV, regardless of how many other investors are also redeeming that day. There’s no order book, no counterparty to find, no spread to absorb.

The practical mechanics: submit your redemption request before the fund’s cut-off time, typically around 3 PM for most equity and debt schemes, and you get that day’s NAV; submit after, and you get the next business day’s NAV instead. Redemption proceeds usually land in your bank account within 2-3 business days for equity funds, though liquid funds often move faster, with many AMCs offering an instant redemption facility for amounts up to ₹50,000 or 90% of your folio value, whichever is lower check current limits with AMFI, since these thresholds can be revised.

Which Actually Has an Advantage: Continuous Trading or Guaranteed Redemption?

Neither wins outright, and the honest answer depends entirely on which specific ETF or fund you’re comparing.

Indian exchanges moved to a T+1 settlement cycle a few years back, which genuinely does make a liquid ETF’s settlement faster than a typical equity mutual fund’s redemption timeline. But speed only helps if the price you’re selling at is fair my ETF settled quickly, at a price nearly 4% worse than it should have been.

There’s a cost layer here too that’s easy to overlook. Every ETF trade, buy or sell, carries brokerage, Securities Transaction Tax, and exchange charges, the same as trading a stock. Direct mutual fund purchases and redemptions, by contrast, typically carry no transaction charges at all beyond the fund’s own expense ratio. For someone trading in and out of an ETF frequently, that cost stack adds up in a way that a mutual fund’s simpler, fee-free redemption doesn’t.

How Do You Actually Check an ETF’s Liquidity Before You Buy It?

This is the step I skipped, and it takes about five minutes once you know what to look for.

1. Check average daily trading volume and value on the NSE website for that specific ETF, not just the category it belongs to two Nifty 50 ETFs from different AMCs can have very different volumes, even when tracking the identical index.
2. Look at the live bid-ask spread on your broker’s order book before placing an order, especially for anything beyond the two or three most popular ETFs in a category.
3. Compare the last traded price to the iNAV shown on your trading app a persistent, meaningful gap is a sign you’d struggle to exit cleanly.
4. Check the AUM trend, not just the current number a fund that’s been shrinking steadily tends to get less liquid over time, not more.

None of this guarantees a smooth exit forever, but it would have shown me exactly what I found out the expensive way five months later.

Can You Actually SIP Into an ETF the Way You Can Into a Mutual Fund?

This is the flip side of the ETF vs mutual fund liquidity question that people rarely think about until they’re already trying to set up regular monthly investing. Mutual fund SIPs are genuinely automatic you set an amount and a date once, and units get purchased at that day’s NAV without you touching the app again.

ETFs don’t work that way by default. Since every ETF transaction is a live market order, buying a fixed rupee amount every month means manually placing an order each time, at whatever the live price happens to be that day, and dealing with the fact that ETF units usually can’t be bought in fractional amounts the way mutual fund units can. Some brokers now offer an “ETF SIP” feature that automates this order placement, but it’s newer, less universal across platforms, and still subject to that day’s bid-ask spread rather than a clean end-of-day NAV.

For someone who wants genuinely hands-off, automatic investing, this is a real practical point in the mutual fund’s favour, separate from the exit-liquidity question entirely, and it’s the kind of detail that only shows up once you’ve actually tried setting up recurring ETF purchases yourself. I now split the two deliberately: SIPs into a mutual fund for the automatic, disciplined part of my investing, and occasional manual ETF purchases only for funds I’ve already checked for liquidity.

Does the Same Liquidity Concern Apply to All Types of Mutual Funds Too?

Mostly no, but not entirely, and it’s worth being honest about the exception. Open-ended funds carry the redemption guarantee described above. Close-ended funds, like Fixed Maturity Plans, don’t offer that same flexibility your money is genuinely locked until maturity, with only limited exchange-listed trading (often with its own liquidity problems) as an exit route.

There’s also a real historical case worth knowing: in April 2020, Franklin Templeton wound up six of its debt mutual fund schemes in India amid a liquidity crunch, leaving investors unable to redeem for months even though these were technically open-ended funds. It’s a reminder that “open-ended” reduces liquidity risk significantly, but doesn’t eliminate it entirely, particularly for debt funds holding harder-to-sell bonds. Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.

So Which Would I Actually Pick for My Own Money?

For a mainstream index Nifty 50, Sensex, gold I’d genuinely consider either an ETF or an index mutual fund now, but only after checking the ETF’s actual trading volume first, not assuming it. For anything more niche, sectoral, or from a smaller AMC, I lean mutual fund, since the guaranteed NAV-based redemption removes the exact risk that cost me money on that IT-sector ETF. The ETF vs mutual fund liquidity comparison genuinely isn’t one-size-fits-all, and treating it as a blanket rule in either direction is how I ended up holding a fund I couldn’t exit cleanly in the first place.

If you’re still deciding between fund categories more broadly, HMA Wealth’s guide to the different types of mutual funds covers the equity-debt-hybrid split this liquidity question sits on top of, and our explainer on expense ratios is worth reading too, since ETFs often win on cost even when they don’t win on liquidity. How much of your money genuinely needs to be this liquid in the first place is its own separate question our piece on the 50/30/20 rule for Indians is a reasonable starting point for that budgeting exercise.

This article reflects personal experience with my own ETF purchase and general research into how these mechanisms work it isn’t personalised investment advice, and HMA Wealth isn’t a SEBI-registered investment adviser or a research analyst. Trading volumes, settlement cycles, and redemption rules can change, so verify current details on the SEBI website or with a certified financial planner before deciding what fits your own situation and goals.

FAQs – ETF vs Mutual Fund Liquidity

Written by Hasanraza Ansari

Founder of HMA Wealth · Empowering India’s Next Generation of Investors

Finance & Operations Expert with 9+ years of experience, dedicated to simplifying wealth creation and helping Indians invest smarter through HMA Wealth.

🌐 Visit HMA Wealth 🔗 Connect on LinkedIn

⚠️

Educational content only. This isn’t personalized financial advice, please do your own research or consult a qualified professional before making financial decisions.