Everything you could ever want to know about ETFs (for absolute beginners)

We’ll explain what they are, how they work, and why so many people use them. Plus, we’ll cover the different types and – perhaps most importantly – the sneaky costs to watch out for when investing.

What is an ETF?

Let’s start with the basics. ETF stands for Exchange-Traded Fund – which sounds like something you’d only ever hear about in a meeting that should have been an email, but it’s actually pretty straightforward once you break it down.

Exchange-Traded: This means the fund’s shares can be bought and sold on a stock exchange (like the London Stock Exchange or New York Stock Exchange), just like shares in Apple or Greggs. 

Fund: This is just a big communal pot of money. Imagine you and thousands of strangers all chucking your cash into a giant cauldron – not for a mystery soup, but to invest in a pre-picked list of stuff.

So, an ETF is a fund that invests in a bundle of things – like companies, bonds, commodities like silver and gold, or even cocoa beans. 

How do ETFs work?

ETFs can be bought and sold whenever the stock market is open. The price isn’t fixed; it moves up and down throughout the day, just like shares in individual companies (stocks).

In fact, open up any trading app and you’ll see ETF prices twitching unsettlingly in real time – sometimes by pennies, sometimes by pounds – depending on supply and demand.

If more people want to buy than sell, the price goes up. If sellers outnumber buyers, it drifts down.

ETFs are (normally, but not always) often passively managed. This means they don’t have a fund manager picking and choosing what to buy, or trying to outsmart the market.

Instead, they’re built to track what’s known as an index – basically, a list of investments (“securities,” if you want to sound fancy) held together in a specific order.

A few classic examples:

• A FTSE 100 ETF tracks the 100 biggest companies listed on the London Stock Exchange. If it’s in the FTSE 100, it’s in your ETF
• An S&P 500 ETF buys a slice of the 500 largest companies in the US. Think Apple, Microsoft, Amazon… and a dash of aerospace manufacturers and ketchup producers thrown in for good measure
• An MSCI World ETF gives you a bit of everything: thousands of companies across dozens of developed countries, from the US to Japan to France
• A UK Gilt ETF invests in UK government bonds (“gilts”), for anyone who likes their investments about as exciting as a trip to the post office.

In all these cases, the ETF simply copies what’s on the list, like a diligent student who never forgets their homework. 

What's the difference between ETFs and traditional index funds?

As we’ve covered, an index fund is just a type of fund that tracks a list of investments.

Traditional index funds (or "mutual index funds") also track an index, but have a slightly different structure. 

A traditional index fund can only be bought or sold once per day at a price set after the markets close. They also have a (normally much higher) minimum investment amount.

An ETF is really a lot like a traditional index fund, but again, you can buy and sell them throughout the trading day. You can invest much smaller amounts, and on many platforms, you can even buy fractional shares (meaning you don’t need to save up for a full share at all). 

So, you might say ETFs are the democratised, modern version of the old-school index fund. 

That's the short version, anyway. For more detail, head here.

Why are ETFs so popular?

ETFs aren't just having a moment – they're having a global takeover.

As of 2025, there's around $16.8 trillion invested in ETFs globally, and that number keeps ticking up faster than the price of a Whetherspoons pint.

So, what's all the hype about?

Cost

ETFs usually have lower expense ratios (annual running costs) than traditional mutual funds or active funds. It’s not unusual to find global ETF trackers with fees as low as 0.07% a year. Cheaper fees mean you keep more of your returns. More on costs later.

Trading flexibility

As we’ve covered, ETFs are traded on the stock exchange all day long. Prices move in real time, so you can buy and sell whenever you fancy – during your lunch break, at 3am if you’re in New York, or just before the market closes because you like a bit of drama.

Access to everything

There’s now an ETF for nearly every investment theme or market you can imagine. Whether you want a slice of the world’s biggest companies, a basket of government bonds, a bet on clean energy or even the performance of companies run by women, there’s probably an ETF for it.

No big minimums

Unlike traditional funds, which might require you to put in £500 or £1,000 just to get started, most ETFs let you buy a single (or fractional) share. So whether you’re investing £5 or £50,000, you get the same access and diversification.

Transparency

ETF holdings are normally published daily (or at least very frequently), so you can always see exactly what you own. That’s a world away from some mutual funds, where you might get a list of top ten holdings once a month if you’re lucky.

Tax efficiency

You can hold ETFs inside a stocks & shares ISA or a self-invested personal pension (SIPP), meaning all your growth and income are shielded from UK tax up to your maximum allowance. No capital gains tax, no dividend tax, no faffing about with HMRC forms. 

Of course, if you hold ETFs outside an ISA or pension, you’ll need to keep an eye on your annual allowances for dividends and capital gains, but inside a wrapper, they’re about as tax-efficient as it gets.

Why are most ETFs passively managed?

History has shown that, when it comes to investing, human beings are often their own worst enemy.

Over decades, fund managers – the professional investors paid handsomely to try and “beat the market” – have, on average, struggled to do just that. 

In fact, study after study (and probably several sad PowerPoint presentations) show that most active managers underperform the market over the long run, especially after you factor in their chunky fees, which are on average 0.69% higher.

It turns out that simply tracking the market often works out better than trying to outsmart it. 

As the saying goes: “If you can’t beat ’em, join ’em.” In ETF land, that means sticking with the index and letting the market do its thing.

The beauty of this is that – unlike stocks – when you’re investing in something like a broad global tracker, there’s no real research required. As Warren Buffett once said: “An idiot with a plan can beat a genius without a plan.”

That said, in the past 12 months alone, a record 85% of new ETFs launched in the US are actively managed. Although active ETFs currently account for just three percent of the European market, the tide could well be turning.

The history of ETFs

It’s 19th October, 1987 – otherwise known as ‘Black Monday’.

No, not a dodgy sale at Debenhams, but the day stock markets around the globe went into full meltdown mode.

The Dow Jones Industrial Average – America’s answer to the FTSE 100, made up of 30 of the biggest and most iconic US companies – plummeted 22% in a single day. 

The shockwaves rivalled those of the Great Depression, leaving investors, regulators, and the financial industry scrambling for answers.

In the aftermath, the US Securities and Exchange Commission (SEC) published an 800-page report, snappily titled “The October 1987 Market Break”. 

Buried deep in this doorstopper of a document was a novel idea: what if there was a way to let people trade entire baskets of stocks at once, rather than having to pick and mix individual companies?

This idea caught the attention of Nate Most and Steve Bloom, two innovators at the American Stock Exchange. 

Most, a physicist-turned-financial-engineer, and Bloom, a specialist in new trading products, saw an opportunity to turn the SEC’s concept into reality. 

They joined forces with State Street, a major US investment company, and in 1993 launched the Standard & Poor’s Depository Receipts, or SPDR (yes – it’s pronounced “spider”).

This was the very first S&P 500 ETF, giving anyone the power to buy or sell the entire US stock market in a single trade, just like buying a share in any other company.

It was a slow burn at first, but the idea caught on. 

Over the next decade, the ETF structure spread beyond the S&P 500, gradually evolving to include bonds, commodities, sectors, and all sorts of strategies that seem completely normal today but were more groundbreaking in the 90s than dial-up internet or Tamagotchis.

P.S., If you'd rather have this explanation passively piped into your ears – and to see all the right buttons to press to actually invest in ETFs – check out the video below from our YouTube channel:

How ETFs track an index

When you invest in an ETF, you might assume it simply goes out and buys all the shares (or bonds) in the index it’s tracking. And often, you’d be right – but not always.

This can get a little complicated, and for most people, it might not even matter. But, it’s always good to know what’s happening behind the scenes with your money.

Full physical replication

This is exactly what it sounds like: the ETF directly owns every single stock or bond in the index, in the exact proportions. For example, a physically replicating FTSE 100 ETF will literally own shares in all 100 companies, matched to their weightings in the index. This is the approach of most ETFs on the market. 

Optimised (or representative) sampling

This is a type of physical replication. Instead of buying every single security in the index (which can be impractical for very large indexes, or those made up of lots of small, rarely traded companies), the ETF manager will buy a carefully chosen subset that closely matches the index’s risk and return profile.

Just to complicate things even further, some funds use physical replication but opt for optimised sampling under certain conditions.

Synthetic replication

This means that instead of actually buying all the assets, the ETF enters into a contract (called a “swap”) with a bank or financial institution. 

This swap guarantees the ETF will receive the same return as the index, even if the ETF doesn’t actually own the underlying shares. The provider might hold a “basket” of other securities as collateral, but it’s not a one-for-one copy of the index.

This type of replication is normally used in “emerging markets” (i.e., markets outside the Western world) because buying and holding every company in the index can be difficult, expensive, or sometimes even impossible.

How do I know which replication method an ETF uses?

You can find out which method any ETF uses by checking the fact sheet from the fund provider. It’ll be right there under “replication method”. Just note that when a fund says "physical replication", this could mean it also uses optimised sampling – this will be explained in the fact sheet, too.

Do different replication methods matter?

The truth is that – for most people – replication methods don’t make a huge amount of difference, and there’s also not much you can do about it.

If you really want to get into the weeds, studies show that funds using optimised sampling can sometimes be a touch more expensive and might lag the index by a tiny bit more than funds that use full physical replication. 

But for practical reasons, this is just how most global or “all-world” funds are built – trying to buy thousands of companies in dozens of countries simply isn’t realistic any other way.

On the other hand, lots of other funds – like those tracking the FTSE 100, S&P 500, or other major indexes with fewer, larger companies – are fully physically replicated.

But all-world funds are often one of the most cost-effective, safest ways to invest, simply because they give you instant diversification across the globe. 

If you get too hung up on the replication method, you could end up missing out on these benefits, so it’s usually better to focus on the bigger picture.

What different types of ETFs are there?

There are more types of ETFs than you could shake a stick at, but here are some of the most common categories:

Equity ETFs. These are the “classic vanilla” option – ETFs that track baskets of shares in companies. They might focus on big, broad indices like the FTSE 100, S&P 500, MSCI World, or zone in on smaller markets like UK mid-caps or emerging markets.

Bond ETFs. For anyone who finds equities a bit too exciting. These track government or corporate bonds, like UK gilts, US Treasuries, or global bond mixes.

Commodity ETFs. If you fancy owning gold (without stuffing your mattress), silver, or even oil, commodity ETFs (or ETCs) let you do just that. Some track the spot price, while others just track companies that do the mining. 

Sector and thematic ETFs. Want to bet on clean energy, healthcare, or the robot revolution? There’s an ETF for that. These funds let you target specific industries you think could beat the stock market in the long-run.

Regional and country ETFs. If you’ve got a hunch about Japan, the US, or “frontier markets” you couldn’t spell point at on a map until year 11 geography, you can buy an ETF that covers just that country or region.

ESG and sustainable ETFs. For those who want to save the planet while (hopefully) making a profit, there are ETFs focused on companies that tick the right environmental, social, and governance boxes.

Leveraged and inverse ETFs. For those who want to amplify their wins (or losses), leveraged ETFs aim to multiply daily returns, while inverse ETFs are designed to rise when the market falls. Not recommended for newbies – or really anyone, for that matter.

Income vs accumulating funds

Just like stocks, ETFs almost always come in two versions: income (or “dividend”) and accumulating. 

A dividend is just a cash payout some companies make to shareholders, normally four times a year (think of it as a little “thank you” for investing).

An income ETF pays out any dividends or interest it collects straight to your account, so you can either withdraw the money or re-invest it yourself. 

An accumulating ETF does the opposite – it automatically reinvests those dividends back into the fund for you, helping your investment grow over time without you having to do anything. 

Each version will have its own ticker symbol (that series of seemingly random letters that comes after the fund name) so even exactly the same fund will have a different ticker depending on whether it’s the income or accumulating version.

Which is better?

The beauty of accumulating comes from the magic of compound interest. Because any growth goes straight back into the fund, over time, you earn returns on an increasingly large amount.

Over time, this snowball effect can give your investment an extra boost, especially if you’re planning to leave your money untouched for years.

Give our compound interest calculator a go to see how this works in practice. 

On the other hand, income ETFs are great if you want regular payouts landing in your account – handy if you’re retired or simply enjoy the thrill of unexpected money showing up, like finding a tenner in last year’s winter coat.

To compare the difference, here's a chart we made earlier showing two brothers – Peter and Paul – investing £10,000 in the same fund. The fund grows by five percent per year and pays out three percent per year in dividends.

Peter chooses to receive dividends and not reinvest them, while Paul chooses the accumulation option, so his dividends are automatically reinvested:

How do you invest in ETFs?

Pretty much every UK broker lets you invest in ETFs these days – some even focus entirely on them. 

You’ll find the widest choice on newer, app-based platforms like Trading 212, which offers thousands of ETFs to pick from. Traditional brokers, like Vanguard, tend to keep things simpler with a smaller, curated selection. 

Roboadvisers (automated investment platforms that build a portfolio for you) usually offer a limited set of ETFs chosen for their particular strategies.

No matter which platform you pick, ETFs are clearly labelled. You’ll usually be able to filter for ETFs, or find them in their own dedicated section, so you won’t have to go hunting through a haystack of funds to find the right one.

Here's what Vanguard's filter looks like:

How much does it cost to invest in ETFs?

This is where things start to get a bit more fiddly, because the costs depend on how and where you invest. There isn’t just one fee to watch out for – there are a few:

OCF/TER: This is the percentage fee charged by the fund manager for running the ETF. It’s the same wherever you buy it. For simple index trackers, these fees are usually tiny – think 0.07% to 0.20% a year. More specialist or thematic ETFs might charge anywhere from 0.30% to 0.75%, so it pays to check.

Platform/account fee: This is what your broker charges you just for holding investments on their platform, or for using a specific type of account (like an ISA or SIPP). This is where costs can really add up, as fees vary wildly. Some platforms are free, some charge a flat monthly fee, and others take a percentage cut (typically 0.25% to 0.45%) of everything you’ve got invested.

Trading fees: This is the charge for actually buying or selling an ETF. Some platforms let you trade for free, while others will charge you a set fee (anywhere from £1 to £12 a pop), especially for shares traded overseas.

Foreign exchange (FX) fees: If you’re buying ETFs listed in a foreign currency (like US dollars), your broker will often sneak in a foreign exchange fee – usually 0.1% to 1% – each time you convert pounds to dollars or back again.

That all sounds quite abstract, so let’s look at how the costs stack up in practice.

We’ll imagine investing £1,000 into the Invesco FTSE All-World ETF (one of the most popular global trackers), held for one year in a stocks & shares ISA across five popular platforms.

Some of the totals are approximate because for brokers that charge a percentage, the amount you’d pay would depend on the return on your investment. We’ve calculated it assuming a nine percent annual return.

Broker	OCF/TER	Platform fee	Trading fee	FX fee	Approx. total
Trading 212	0.15%	£0	£0	n/a (0.15% when applicable)	£1.50
InvestEngine	0.15%	£0	£0	n/a (all funds denominated in GBP)	£1.50
AJ Bell	0.15%	0.25%	£5	n/a (0.75% when applicable)	£9.23
Hargreaves Lansdown	0.15%	0.45%	£11.95	n/a (1% when applicable)	£18.36
Vanguard	0.15%	£48 (£4/month)	n/a (when bought using batch dealing)	n/a (not charged on any Vanguard funds)	£49.50

As you can see, that's nearly a whopping £50 difference between our cheapest and most expensive broker – enough to buy a tank of petrol or approximately half a round in central London.

If you want to see at a glance how different broker costs compare, we’ve done all the hard work for you. Just use our broker comparison tool. You should also check out our free index fund cheat sheet – sign up below and we'll send it right over.

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Bid-ask spread: a cost hiding in plain sight

When you buy or sell an ETF, you’ll notice there’s a tiny gap between the buying price (the “ask”) and the selling price (the “bid”). This is called the bid-ask spread – and technically, it’s a cost you pay every time you trade.

For popular ETFs (like those tracking the FTSE 100 or S&P 500), this spread is usually minuscule – often just a penny or two per share – so most long-term investors barely notice it.

For more niche, thinly traded ETFs, though, the spread can be wider, quietly nibbling at your returns if you’re buying or selling in big chunks – so just watch out.

Using a limit order instead of a market order can help here, as it lets you set the maximum price you’re willing to pay (or the minimum you’ll accept when selling), rather than just taking whatever price the market offers.

This does get a little technical though, so be sure to read our guide to different market order types first.

If you’re sticking to big index trackers, it’s nothing to lose sleep over. But, at least now you can casually drop it into conversation and sound like the cleverest person at the school gates.

Bottom line

ETFs are one of the simplest, cheapest, and most flexible ways to invest – and that’s exactly why so many people use them.

They’re basically modern index funds that you can buy and sell throughout the day, with low fees, no high entry costs, and access to just about every part of the market.

You can hold them in a tax wrapper like a Stocks & Shares ISA or SIPP, so your returns grow free of capital gains and dividend tax. And once you know your way around costs like OCFs, platform fees, and bid-ask spreads, it’s not all as complicated as it sounds.

So the next time someone mentions ETFs, you’ll actually know what you’re talking about. And maybe even impress them with a fun fact about replication methods or the first-ever SPDR.

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