Jasmine Birtles
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What Are Exchange-Traded Funds (ETFs)? A Complete Guide
Karl
24th Mar 2025
Alright, let’s talk about Exchange Traded Funds—because let’s be honest, the finance world loves its jargon! ETF stands for Exchange-Traded Fund, and while that might sound fancy, it’s really just a basket of investments (like stocks, bonds, or commodities) that you can buy and sell on the stock market—just like you would a share in a company.
ETFs let you invest in a whole bunch of things at once, rather than putting all your eggs in one basket. Think of it like a shopping basket full of different groceries instead of just buying 50 loaves of bread (because no one needs that much bread).
In this guide, we will take a look at everything you need to know about exchange-traded funds so that you can navigate this corner of the market with confidence.
What is an Exchange Traded Fund (ETF)?
Introduced in 2001, an ETF is an investment vehicle that tracks the performance of an underlying group of investments. For example, an ETF might mirror the performance of a particular industry, commodity, or major stock market index.
Because of how they work, ETFs are an efficient way for investors to gain exposure to lots of different assets without the need to purchase individual shares, bonds or commodities.
In addition, the potential diversification benefits offered by ETFs could be huge.
As we’ve covered a number of times here at Money Magpie, every investor should seriously consider diversification when putting together a portfolio. That’s because diversification can go a long way in helping to mitigate risk.
ETF Meaning
Let’s break it down:
- Exchange-Traded: This just means that ETFs are bought and sold on stock exchanges throughout the day, just like company shares.
- Fund: A pool of money from lots of investors, all used to buy a diversified mix of investments.
So, in simple terms, an ETF is a mix of investments you can trade on the stock market whenever you like. It’s like a mutual fund, but with more flexibility and often lower costs. Win-win!
How Do ETFs Work?
ETFs are designed to track the performance of a particular index, sector, commodity, or asset class.
For example, let’s say you want to invest in the biggest companies in the UK—you could buy an ETF that follows the FTSE 100, which includes the top 100 companies on the London Stock Exchange.
Instead of picking individual stocks (which can be risky and time-consuming), you just buy shares in an ETF, and boom—you’ve instantly got a slice of all those companies.
It’s like buying a ready-made cake instead of baking one from scratch
Income or growth?
Similar to mutual funds, ETFs typically offer ‘distributing’ and ‘accumulating’ units.
For distributing funds, dividend income is paid to investors at regular intervals, usually quarterly or annually.
On the other hand, with accumulating funds, any income is automatically reinvested back into the fund, rather than being paid to the investor. For investors looking to potentially benefit from compound interest, an accumulating fund could be the way to go.
Types of ETFs
There are various types of ETFs which cater to all kinds of investors. From equity, sector-specific, to international, here’s an overview of some prominent types of ETFs:
Equity ETFs:
Equity funds track the performance of stock market indices, such as the FTSE 100 or FTSE All-Share Index.
So, if you buy a FTSE 100 ETF its value will move in parallel to the collective performance of the 100 constituents within the index.
Sector-Specific ETFs:
If you’re looking to gain exposure to a single sector, then a sector-specific ETF could be for you.
As its name suggests, sector-specific ETFs track the performance of specific industries. For example, if you buy a healthcare ETF then your investment will mirror the performance of a range of healthcare stocks.
Thematic ETFs:
Thematic ETFs target specific trends and evolving industries, such as renewable energy. Thematic ETFs could be ideal for investors looking to put their capital towards a particular cause or industry they believe in.
Thematic ETFs are particularly popular with investors looking to make investing decisions that align with their personal values. For example, they might invest in an ETF that tracks the performance of socially responsible industries.
Bond ETFs:
Bond ETFs, or ‘gilts’ as they’re known in the UK, track the movement of the bond market. For investors looking to complement their equity holdings, investing in bond ETFs may provide some balance to a portfolio.
Commodity ETFs:
Gold, silver, oil, natural gas, and wheat are all examples of commodities. While investors can invest directly in these individual commodities, buying a targeted ETF which tracks an underlying commodity index is probably the easiest way to gain exposure to commodities.
For example, if you’re seeking exposure to gold, then buying the precious metal directly will mean you’ll need to consider the costs of storage, insurance, and even transport. However, with an ETF that tracks the price of gold all this can be sidestepped. Other risks are any way involved.
International ETFs:
For investors keen to explore opportunities away from the UK, an international, or global ETF, could be the answer.
International ETFs can track the performance of an overseas stock market or country-specific benchmark. International ETFs may also be used to describe ETFs that mirror the performance of emerging markets.
Why Invest in ETFs?
There are plenty of good reasons to love ETFs:
- Diversification: ETFs spread your money across lots of different investments, lowering the risk of one bad apple ruining the bunch.
- Flexibility: Unlike mutual funds, which only trade once a day, you can buy or sell ETFs whenever the stock market is open.
- Cost-effective: Most ETFs have lower fees compared to traditional funds, meaning you keep more of your hard-earned cash.
- Transparency: You can always check what’s inside your ETF. No hidden surprises!
Things to Consider Before Investing in ETFs
ETFs are fantastic, but they’re not totally risk-free (nothing in investing is!). Here are a few things to watch out for:
- Market risk: If the market drops, your ETF will drop too—because it follows the market.
- Tracking error: Some ETFs don’t perfectly mirror the performance of the index they’re tracking. It’s a bit like following a GPS that occasionally takes you on a detour.
- Liquidity: Some ETFs are easier to buy and sell than others. If an ETF isn’t traded often, you might struggle to sell it quickly.
How to invest in an ETF
Now we’ve covered what ETFs are and how they work, you may be wondering how to invest in one.
As mentioned above, one notable characteristic of ETFs is how easy they are to buy. Just like with stocks and shares, ETFs can be bought and sold on a stock exchange.
So, if you’re thinking of buying an ETF, you’ll first need to find a suitable brokerage account. As with any type of investing, always pay close attention to fees as hefty charges can eat into your returns.
Take a look at our overview of the best UK investment platforms to find the perfect platform for you!
| Platform Name | What We Like | What We Don’t Like | Minimum Deposit |
|---|---|---|---|
| InvestEngine | The best ETF platform that offers zero commissions on stocks and shares, fully managed protfolios, and up to £4000 cashback for new ISA accounts. | Only offers ETFs, no access to cryptocurrencies | £100 |
| XTB | Zero commission on stocks and shares, invest in ready-made portfolios for passive investing, access over 6000 assets | XTB does not provide access to cryptocurrencies | £1 |
| eToro | Social trading, copy trading, free demo account, access to stocks and crypto | No pension options, high fees | $10 |
Once you’ve chosen a brokerage account, you can then begin your search for a suitable ETF to invest in.
ETFs are a great way to dip your toes into investing without needing to be an expert stock picker. They give you instant diversification, are easy to trade, and come with lower fees than many traditional funds. Whether you’re investing for the long term or just starting out, ETFs can be a smart addition to your portfolio.
Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.
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