What is an ETF?

Instead of buying shares in a single company, an ETF can give you exposure to hundreds or even thousands of companies.

Some ETFs invest in shares, while others focus on bonds or other types of investment.

They're called Exchange Traded Funds because they're bought and sold on a stock exchange, just like shares. You buy and sell ETFs through your investment account in much the same way as you would buy and sell individual shares.

For many investors, ETFs offer a simple way to build a diversified portfolio.

How does an ETF work?

Many ETFs are designed to track the performance of a particular market index, such as the FTSE 100 or S&P 500. This means they aim to reflect the performance of that market, rather than trying to outperform it.

Because many ETFs track an index rather than relying on a fund manager to choose investments, they often have lower ongoing charges than actively managed funds.

Why do investors choose ETFs?

Some of the reasons include:

• Diversification through a single investment.
• Lower costs than many actively managed funds.
• The ability to buy and sell during normal stock market opening hours.
• Access to different markets, sectors and asset classes.

What else is good to know?

Before investing in any ETF, it's worth taking a few minutes to read its Key Information Document (KID) and factsheet. These explain how the ETF works, what it invests in, the risks involved and whether it's a physical or synthetic ETF.

Most ETFs invest directly in the assets they track, such as shares or bonds. These are known as physical ETFs.

Some ETFs use financial contracts (called derivatives) to track an index instead. These are known as synthetic ETFs and can involve additional risks because they rely on another financial institution to deliver the expected return (known as counterparty risk).

If you're comparing ETFs, it's worth checking whether they're physical or synthetic, as this can affect how they track an index and the risks involved.

Things to check before you invest

Once you've decided an ETF might be suitable, it's worth considering:

• What does it invest in? Some ETFs invest in UK companies, while others focus on global shares, bonds or a particular sector. Two ETFs may sound similar but invest in very different assets.
• What are the charges? Lower costs can make a difference to your investment returns over the long term.
• Does it fit your goals? Think about your investment objectives, timescale and attitude to risk. Some ETFs aim to track broad global markets, while others focus on a single sector, region or investment theme.
• Accumulation or income? Accumulation ETFs automatically reinvest any dividends or interest earned by the investments they hold, helping your investment grow over time. Income ETFs pay those returns out to investors instead.

What to bear in mind

Like any investment, the value of ETFs can go down as well as up, so you could get back less than you invest.

ETFs can be a simple way to build a diversified portfolio, but it's still important to understand what you're investing in. Taking a few minutes to check what an ETF invests in, its costs and whether it matches your investment goals can help you make more informed investment decisions.