Make money make sense
Make every penny count. Get the best deals, avoid scams, and grow your savings with expert guidance for only £49 a year.
Join Which? MoneyBy clicking a retailer link you consent to third-party cookies that track your onward journey. This enables W? to receive an affiliate commission if you make a purchase, which supports our mission to be the UK's consumer champion.
What is an ETF?
Exchange-traded funds can give you access to a range of investments
Megan is a senior researcher and writer at Which?, with a background in data analysis and stats in the public and charity sectors.
An ETF, short for exchange-traded fund, is a type of investment available in stocks and shares Isas and other investment accounts.
They are an increasingly popular option for easily investing in a range of stocks or bonds.
Please note that the information in this article is for information purposes only and does not constitute advice. Please refer to the particular terms and conditions of an investment platform before committing to any financial products.
How do ETFs work?
When you invest in any fund, including an ETF, your money is pooled with others who've invested in the same fund.
Instead of going into just one stock, your money is spread across a broad range of stocks, or other types of investment, which is a crucial part of diversification.
This can reduce the risk you take on because you’re not so reliant on the performance of a single company’s shares (or single bond, in the case of ETFs specialising in bonds).
ETF vs mutual fund
The main difference between ETFs and other types of funds, such as mutual funds, is that ETFs are bought and sold on a stock exchange.
As an investor, you buy shares in the ETF instead of directly buying units of the fund. This means you can invest at any time when the stock market is open, whereas funds can only be bought and sold once a day.
There are some risks with ETFs that don't come with mutual funds. Many ETFs lend shares out to hedge funds or banks to bet on the price of the share going down, for a fee.
This can help reduce the cost you pay for the management of the ETF, but also risks driving down the value of the shares in it.
Are your trades really instant?
ETFs have a advantage over mutual funds in that you can trade them across the day.
This means you could, in theory, quickly buy and sell ETFs to profit from events in the news.
However, you should check that your investment platform actually executes ETF trades in real time, as some only do this once a day, with orders to buy and sell being having to be received by a certain time.
Keep in mind that, over the long term, time in the market is more important than timing the market.
Are ETFs good for beginners?
ETFs have a major advantage over picking stocks yourself, because don't need to build the same level of company-specific knowledge and you don't need the same level of confidence.
Investing in a larger number of stocks or bonds spreads out the risk and means if some of your investments lose value, others which haven't or have increased in value will balance out this effect.
ETFs don’t have the same minimum investment requirements as some mutual funds, meaning you don’t need as much money to get started.
But, not all ETFs are equally beginner-friendly.
You can check the individual level of risk involved in each ETF on the Key Investor Information Document (KIID) provided when you invest, this is currently rated from 1-7.
ETFs that are labelled 'UCITS' follow a set a standards (including ensuring the investments are spread out) which add extra protection from risk, though as with any investment, they still carry a risk that you could lose money.
Avoid leveraged ETFs
Some ETFs are leveraged, which means gains and losses are multiplied.
They are not part of a long-term investment strategy and only focus on a single day’s gain or loss, and are only suitable for very experienced and knowledgeable investors.
Again, it's best to use ETFs as part of a long-term investment strategy.
How much do ETFs cost?
When you invest in an ETF, you'll pay some management fees and you might also pay a fee to the platform you use when you buy or sell an ETF.
- An on-going charge figure (OCF) to cover the costs of managing the fund. This is usually low for an ETF, on average 0.23% of the amount you have invested, according to investments data provider Morningstar.
- Because ETFs are traded on the stock market, you'll usually pay the same trading fees to buy or sell that would apply to stocks. These are generally higher than fees for buying or selling a mutual fund.
- Platforms might take a cut from the from the difference between the price you pay, and how much ETF or share actually cost to invest in. This is known as the 'bid-offer spread'
If you are considering switching investment platform or stocks and shares Isa, and want to invest in largely or entirely in ETFs, you'll need to weigh up trading fees, the bid-offer spread and fees charged by platforms to hold ETFs.
Some platforms charge lower on-going fees for ETFs than other types of investments, and some charge no fees at all.
- Find out more: Are fund charges eating into your returns?
How to pick the right ETF
ETFs are usually passively managed, which means they are tracking an index (for example the FTSE 100 or S&P 500), rather than someone choosing specific stocks.
Some ETFs track indexes exactly, so you'll have all of the same stocks listed, while others are only partially replicating and, for example, missing same of the smaller holdings.
You might find ETFs tracking the same index, but with slightly different results.
If you’re shopping around for ETFs to invest in, look at the ‘tracking error’ in a fund’s annual report. This tells you the difference between the fund’s returns and the index it’s tracking.
Sometimes ETFs are based around specific themes, for example space travel or mining companies.
If you only invest in an ETF focusing on a specific theme, you’ll be vulnerable to any potential shocks or crashes that are specific to that market.
You're better off spreading your money across several industries and regions – it's even possible to get ETFs which promise to track global markets (even if, frequently, they are largely invested in the US).
- Find out more: How to balance your investment portfolio
What are ETCs and ETNs?
There are other types of exchange-traded products, as well as ETFs. There are also exchange-traded commodities (ETCs) and exchange-traded notes (ETNs).
ETCs are a way of trading commodities such as oil or gold on the stock market.
ETCs are either 'synthetic' or 'physical':
- Physical ETCs buy the components, for example a real store of gold
- Synthetic ETCs do not own the underlying commodities but instead a derivative which aims to match the performance of those commodities. They are usually used for access to investments that are more difficult to buy and sell.
An ETN also doesn't own the underlying assets it tracks, but works more like a bond that is issued by a financial organisation which pays you a return that mirrors the index. If the organisation behind the ETN goes bust, you would lose some or all of your investment.
Both of these are not suitable for beginners, and should only be considered by those with a high level of knowledge and experience as the risk is so high.