What are ETFs?

Learn everything you need to know about the booming ETF market, including what exchange traded funds are, how they work, and how to invest in ETFs.

What is an ETF?

An exchange-traded fund, or ETF, is a type of collective investment. They’re also called ‘passive’ or ‘tracker’ funds because, unlike an active fund, the fund manager is ‘passive.’ That means they don’t try to outperform a specific stock market index (such as the FTSE 100).

How do ETFs work?

ETFs aim to follow, or ‘track,’ the index’s performance. If the underlying index moves up or down by a certain amount, the ETF should do the same minus its charges. Other indexes that ETFs track include bonds, a selection of commodities or a basket of companies share index.

Because ETFs are not actively managed, there’s no risk of fund manager error. It also means lower fees, coming in around 0.3% to 0.5% a year – sometimes even cheaper. The downside is that, unlike a (well-managed) active fund, an ETF won’t beat a benchmark, just track it.

Learn more about the difference between active and passive investing.

The benefits of investing in ETFs

There are many advantages of investing in ETFs, including:

•   Diversification: With an ETF, you can access whole asset classes, geographies and specific sectors. And because an ETF offers exposure to an index that is itself a broad basket of securities, your portfolio is diversified even further, reducing your overall risk.
•   Specialisation: With an ETF, you can target a specific theme, such as an individual country, industry or kind of investment, such as small caps.
•   Easily traded: ETFs are easy to trade during normal market conditions.
•   Low cost: ETF annual fees are as low as 0.10%, with the standard 0.35% to 0.5%.
•   Tax efficient: ETFs aren’t subject to the 0.50% stamp duty, while London-listed ETFs are SIPP and ISA-eligible.
•   Transparency: ETFs are required to list all the companies they invest in, and the amounts of all their investments, while traditional vehicles like open-ended investment companies (OEIC) are only required to list the top 10 holdings.

Are there any downsides to ETFs?

Investing in ETFs isn’t without potential drawbacks. For example:

• ETFs are unlikely to outperform their benchmark index – they just track it (minus the running costs and fees)
• Index-matching performance isn’t guaranteed and tracking differences can mean the fund falls short of the index's performance
• Tracking errors can cause volatility in the ETF's quoted price relative to changes in the underlying benchmark

When choosing an ETF, it’s important to keep these considerations in mind.

What’s the difference between ETFs and funds?

'Traditional’ investment funds have a fund manager or team of managers run a portfolio of assets. These managers actively decide what goes in or out of the portfolio, which is why these funds are known as ‘active’ funds.

ETFs are generally known as ‘passive’ funds because what goes into their portfolio is dictated by whatever qualifies for the underlying index being tracked.

Active funds typically have higher charges than ETFs because there is a real person making portfolio decisions. They are priced once a day, whereas ETFs trade on the stock market and their prices are constantly changing.

A changing ETF landscape  

ETFs have grown dramatically in the past 10 years across the UK. The total amount of money invested into ETFs on the London Stock Exchange for the whole of 2024 was £158.94 billion. As of December 2024, there was a total of £1.27 trillion worth of assets in ETFs on the London Stock Exchange, which had grown by over 30% year-on-year.  

Many ETFs are focused on stocks and shares. But bond funds and alternatives are also working their way onto the market. As fast as money is flowing into ETFs, providers are also creating plenty of new products. There are now almost 2,000 ETFs available on the London Stock Exchange, with 2024 bringing over 200 new products to the market.  

Finally, it’s worth noting the rise of active ETFs. While this type of investment product is generally associated with the passive form of investing, active ETFs are being rolled out, albeit they only make up a tiny proportion of the ETF universe.

How to buy ETFs

Investing in ETFs is simple. You can buy and sell them online just like shares, as they are traded in places like the London Stock Exchange. This means you can get an online quote between 8.00am and 4.30pm Monday to Friday.

You can buy ETFs like ordinary shares and add them to the account you hold with us, whether it's an ISA, pension or Dealing account.

We have a wide range of ETFs for you to choose from. For buying and selling ETFs, we have a £5.00 online dealing charge and an account charge for holding the fund. You’ll also pay a charge to the fund itself – usually called the fund manager's charge.

These charges are included in the fund price and can be found on the fund factsheet. Learn more about our charges and rates.

Browse our ETF offering Use our ETF screener

How to invest in ETFs regularly

You can save from £25 per month into a wide range of tracker funds using our regular investment service. Simply set it up online, and we’ll invest automatically every month into the fund of your choice. It’s an excellent way to save regularly and build up your portfolio.