What Is an ETF? Exchange-Traded Funds Explained for Beginners

The short version

An ETF, short for exchange-traded fund, is a fund that you buy and sell on a stock exchange, just as you would a company’s share. One ETF can hold hundreds or thousands of investments, so it gives you the spread of a fund with the convenience of a share. Most ETFs are low-cost index trackers.

You get: A slice of a fund, traded on a stock exchange
Typical costs: Yearly charge (often 0.03% to 0.5%), dealing fees, spread
Can you lose more than you put in?: No
Risk: Medium

An ETF holds a basket of investments, usually copying an index such as the S&P 500 or a global share index.
Its price moves through the trading day, and you buy it through a broker like a share.
Broad index ETFs are among the cheapest ways to invest in the stock market, with yearly charges that can be below 0.1%.
Not all ETFs are simple. Leveraged and inverse ETFs are built for short-term trading and can lose money even when you guess the direction right.

How an ETF works

An ETF is a fund (see our funds guide) whose units are listed on a stock exchange. Instead of sending money to a fund manager and getting a price once a day, you buy units from other investors through your broker, at the live price, any time the exchange is open¹.

Behind the scenes, big financial firms called authorised participants create new ETF units when demand rises and cancel them when it falls. This keeps the ETF’s price very close to the value of what it holds. You don’t need to do anything about it; it just means the price you see is fair most of the time.

Many ETFs pay out the dividends from the companies they hold. Accumulating ETFs reinvest them for you automatically, while distributing ETFs pay them to you in cash.

Types of ETF

Broad index ETFs track a whole market, such as global shares, the US market or the UK market. These are what most long-term investors use.
Bond ETFs hold government or company bonds (see our bonds guide).
Sector and theme ETFs hold one industry or idea, such as technology, clean energy or robotics. They’re far less diversified and tend to be more expensive.
Commodity ETFs and ETCs track things like gold. In the UK and Europe these are often called ETCs (exchange-traded commodities). Our gold and silver guides cover them.
Leveraged and inverse ETFs aim to deliver two or three times the daily move of an index, or the opposite of it. See the risks section before going anywhere near these.

What it costs

Yearly charge, shown as the TER, OCF or expense ratio. Broad index ETFs often charge 0.03% to 0.25%.
Dealing fee: whatever your broker charges per trade, from zero to a few pounds or dollars.
Spread: the gap between the buying and selling price. Tiny for big, popular ETFs, wider for small or niche ones.
Currency fees if you buy an ETF priced in another currency.

UK buyers pay no stamp duty on ETFs, unlike most UK shares.

The risks

An ETF carries the risks of whatever it holds. A share ETF falls when markets fall; a single-country or single-sector ETF can fall much further than a global one.

Rules where you live

Products, protections and tax rules differ from country to country. Here’s a summary for the main English-speaking markets. Always check your own regulator for the latest position.

UK: ETFs can sit in a Stocks and Shares ISA or SIPP. Most ETFs sold to UK investors are listed in London and based in Ireland or Luxembourg. Many US-listed ETFs haven’t been available to UK retail investors because of disclosure-document rules; those rules have been changing, so check what your platform offers. For overseas ETFs held outside an ISA or pension, check the fund has HMRC reporting fund status, which affects how gains are taxed.
US: ETFs are regulated by the SEC and are widely available from almost every broker, often commission-free. They’re usually more tax-efficient than mutual funds in taxable accounts.
EU: ETFs sold to retail investors must publish a key information document, which is why US-listed ETFs are usually unavailable. Most EU investors buy UCITS ETFs listed on European exchanges.
Australia: Hundreds of ETFs trade on the ASX and Cboe Australia, and you can hold them in an ordinary brokerage account or some superannuation funds.
Canada: Canadian-listed ETFs trade on the TSX and can go in a TFSA or RRSP. Canada also has popular all-in-one ETFs that hold a ready-made mix of shares and bonds.

Who it tends to suit

Tends to suit

Beginners who want a cheap, diversified long-term investment.
People who like to see a live price and control exactly when they buy and sell.
Investors building a simple portfolio from two or three broad ETFs.

Think twice if

Anyone tempted by leveraged, inverse or very narrow theme ETFs without understanding them.
People who would trade in and out every day just because they can.

How to get started safely

Open an account with an authorised broker, ideally inside a tax-free or pension account.
Look at broad, low-cost ETFs first: a global share ETF, and possibly a bond ETF.
Check the yearly charge, the fund size (bigger funds tend to have tighter spreads) and whether it accumulates or distributes dividends.
Place your order while the exchange is open and avoid the first and last few minutes of the day, when spreads can be wider.
Invest regularly and leave it alone.

Words in this guide

ETF (exchange-traded fund): A fund whose units trade on a stock exchange like a share.
ETC (exchange-traded commodity): A similar product that tracks a commodity such as gold.
TER / OCF / expense ratio: The yearly cost of running the fund, as a percentage of what you hold.
Accumulating / distributing: Accumulating funds reinvest dividends automatically; distributing funds pay them to you.
Authorised participant: A large firm that creates and redeems ETF units to keep the price close to the value of the holdings.
Leveraged / inverse ETF: An ETF that aims for a multiple of an index’s daily move, or the opposite of it. Designed for short-term trading.

Frequently asked questions

Are ETFs good for beginners?

Broad, low-cost ones can be. A single global share ETF spreads your money across thousands of companies for a small yearly fee, and you can buy it through most brokers in a tax-free account. The ones to avoid at the start are leveraged, inverse and narrow theme ETFs, which behave very differently from what their names suggest.

Is an ETF better than an index fund?

Neither is better in general. Both can track the same index at similar cost. ETFs trade during the day at a live price; traditional index funds trade once a day. Choose based on what your platform charges for each.

Can an ETF go to zero?

A broad ETF holding thousands of companies would need nearly all of them to fail at once, which is extremely unlikely. Narrow or leveraged ETFs can lose most of their value, and some have closed after heavy losses.

Do ETFs pay dividends?

Many do. Distributing ETFs pay out the dividends from their holdings, usually every quarter or half-year. Accumulating ETFs reinvest them, so the unit price grows instead.

Sources and further reading

Numbers in the guide, like ¹, point to these sources. Rules, fees and tax change, so check the latest version before you act.

Exchange-Traded Funds (ETFs) Investor.gov (SEC).

What to read next

Investment Funds Explained: Index Funds and Managed Funds: Pool your money with other investors so one purchase buys a spread of many investments.
Robo-Advisers and Ready-Made Portfolios Explained: Answer a few questions and a provider invests and rebalances a mix of funds for you.
Stocks and Shares Explained for Beginners: Buy a small piece of a company and share in its growth and profits.
All ways to trade and invest compared