A basket you can buy in one go
A fund pools money from many investors and invests it in a mix of assets. Instead of buying 100 different companies yourself, you buy units of a fund that already holds those 100 companies.
What makes an ETF different from other funds is where you buy it. Its units trade on a stock exchange during the day, like a share, so the price you pay changes as the market moves.
Index tracking
Many ETFs follow an index. An index is a list of companies or bonds chosen by fixed rules, for example the largest companies in a region. The ETF tries to hold the same things in roughly the same proportions, so its value moves up and down with the index.
Tracking an index does not protect you from losses. If the index falls 20%, an ETF that follows it will fall by about the same amount. What you gain is spread: one company doing badly has a smaller effect on your total.
A worked example of spreading
Say you invest €1,000 in a fund that holds 100 companies in equal amounts, so each one is about €10 of your money. If one of those companies goes bankrupt, you lose about €10 of the €1,000, all else being equal. If you had put the full €1,000 into that one company instead, you would lose the whole €1,000.
Funds also charge a yearly cost, shown as a percentage. A yearly cost of 0.2% on €1,000 is €1,000 × 0.002 = €2 a year. Why small percentages still matter is covered in why fees matter.
Accumulating vs distributing
ETFs that hold dividend-paying shares or interest-paying bonds receive income. There are two common ways a fund handles it:
- Accumulating: the fund reinvests the income itself, so it shows up as a higher fund price rather than cash in your account.
- Distributing: the fund pays the income out to you as cash from time to time.
The KID and the EU rules
For packaged investment products sold to retail investors in the EU, the seller must give you a Key Information Document (KID) in good time before you buy, free of charge. It is at most three sides of A4 and includes sections titled "What is this product?", "What are the risks and what could I get in return?" and "What are the costs?". Reading it is a good habit before buying any fund.
Funds set up under the EU UCITS Directive must invest on the principle of risk-spreading. That limits how much of the fund can sit in one issuer, but it does not mean the fund cannot lose value.
Which version, accumulating or distributing, works better for you can depend on how your country taxes fund income. See the country rules, and do not choose based on tax guesses.