How to Invest in ETFs

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Contents:

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The easiest way to invest in ETFs in the UK is to buy them online from a stockbroker or investment platform, such as InvestEngine, XTB, or Interactive Investor.

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These platforms not only facilitate the buying and selling of ETFs but also provide the resources, guidance, and educational materials needed to create an investment portfolio, regardless of your level of experience or investment knowledge.

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Follow the steps below to invest in ETFs in the UK:

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1. Create an account with an investment platform, such as InvestEngine or Interactive Investor. An investment platform is a broad term for any broker, app, or website that allows you to purchase investments. There are a vast number of options to choose from, all with their own pros and cons. If you are looking for a cheap way to buy ETFs, the cheapest way to buy ETFs in the UK is to purchase them online from commission-free fractional ETF providers, such as XTB, InvestEngine, and Freetrade. Scroll down for a detailed comparison of several of the best ETF platforms in the UK.
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2. ‍Verify your details and fund your account using a debit card or via bank transfer. Depending on the platform you choose, you might need to submit your national insurance number or upload a copy of a valid ID card, such as your passport or driving licence, to create your account. Once your account is created, you’ll need to add funds to it.
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3. Choose a tax wrapper, such as an ISA or SIPP. A tax wrapper reduces the amount of taxes you pay on the gains from your investments. Some examples include a Stocks and Shares ISA, Lifetime ISA, or Private Pension. Keeping taxes down can significantly affect your long-term gains, so it is worth taking the time to choose the best option.
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4. Research ETFs. Before investing in any stock market product, it is crucial to carry out some research. For investors at all levels, we have put together a guide to help speed up your research process: Best ETFs in the UK.
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5. Create an investment strategy, such as the Bogleheads’ three-fund portfolio. Most people follow the Bogleheads’ Three-Fund Portfolio strategy, which suggests building a three-fund portfolio composed of only basic asset classes, usually a domestic stock “total market” ETF, an international stock “total market” ETF, and a bond “total market” ETF. Others simply invest in one ETF that tracks the whole world. We explain both strategies in detail in the How to Build a Portfolio of ETFs section below.
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6. ‍Choose and invest in your preferred ETFs using the platform’s web or mobile app. The next step is to choose the ETFs you want to invest in within your new account. This is not a case of just picking the ones that offered the best returns from last year. You need to decide on an investment strategy and then find ETFs that match it.
   
   Do you want to invest in the US, the UK or a mixture of the “total” world stock markets? Do you want to invest only in stocks, or do you want some bonds and property investments, too? Are you investing for income or capital growth? Different ETFs will offer strategies and investments that align with your answers to these questions.
   
   Once you have done all the above, you can start buying ETFs. Enter the name or ticker symbol of the ETF into the search bar of your preferred ETF broker’s desktop or mobile app. For example, you can type in “iShares NASDAQ 100 ETF” or “CNDX”. Once you locate the ETF, you may buy as many units as you want.
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7. ‍Invest small amounts regularly to take advantage of pound-cost averaging. It is important to keep on investing small amounts into your portfolio regularly. Investing small amounts regularly is known as “drip-feeding” into your investment pot and can sometimes be better than investing a huge lump sum once. This investment strategy is often called dollar-cost averaging or pound-cost averaging. It is a technique that minimises the risk of market volatility by spreading out your investments over time, leading to buying more units when prices are low and fewer when prices are high.
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8. ‍Monitor your portfolio and rebalance when necessary. Once you find your rhythm, remember to keep an eye on your investments and rebalance your portfolio when necessary. Remember, investing isn’t a set-it-and-forget-it kind of endeavour. It is a dynamic process that requires consistent attention and maintenance.

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We’ve compiled a list of the best ETF platforms in the UK. These are the best platforms for buying, selling, and holding UK and overseas ETFs, ETF CFDs, index funds, and other investment products.
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Please remember that when you invest, your capital is at risk. ISA, pension, and tax rules also apply.
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The platforms listed below are authorised and regulated by the UK’s financial watchdog, the Financial Conduct Authority (FCA).
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Here are the best ETF platforms in the UK:

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Picture yourself at a lively farmer’s market. Instead of individually picking each apple, tomato, or pear, you could simply grab a pre-packed basket filled with a wide variety of fresh produce. In the financial world, an ETF, or exchange-traded fund, is quite like that basket.

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An ETF is a collection of different assets, such as stocks, bonds, or real estate. Now, imagine if the farmer’s market had a master list of top-quality produce compiled by seasoned grocers. If we call this list an “index,” a typical ETF could be seen as a basket that mirrors the assortment on that list.

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In financial terms, an index is a selected portfolio of stocks representing a particular segment of the market. For instance, an index could consist of large companies, small companies, companies within a certain industry, or companies from a specific country. A well-known index is the FTSE 100, which includes 100 of the largest companies in the UK. Another renowned index is the S&P 500 from the US, which consists of 500 of the largest US companies.

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Some ETFs aim to track the performance of these indices. So, if you invest in an ETF that shadows the FTSE 100 or the S&P 500, you are essentially buying a small portion of each of those companies in the index.

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However, ETFs aren’t limited to just passively tracking an index. Some ETFs are actively managed, meaning they have a portfolio manager who makes decisions about which assets to buy or sell within the ETF. Their goal is to outperform the index, which is like having a skilled farmer hand-select the best produce to surpass the quality of the pre-made basket.

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And here’s the twist: ETFs aren’t just about stocks. They can also encompass bonds (loans to governments or corporations), real estate, and even a blend of these.

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So when you invest in an ETF, whether it’s passively tracking an index or actively managed, you’re spreading your risk and potential returns across a range of assets, from different companies to various types of financial instruments. It’s like enjoying an array of produce from the farmer’s market without having to buy each item separately!

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Carrying forward our farmer’s market metaphor, let’s say you wanted to try all the market had to offer but only had a limited budget. Would you spend all your money on just the apples, or would you rather grab that diverse pre-packed basket to get a taste of everything? If you chose the latter, you’ve just grasped one of the main reasons to invest in ETFs!

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1. Diversification: In finance, as in our market, putting all your eggs—or apples, in this case—in one basket can be risky. If that one company (or apple vendor) you invested in doesn’t perform well, your entire investment is in jeopardy. ETFs, however, spread your investment across a wide range of companies or assets. Just like that market basket, an ETF lets you sample the whole market, potentially reducing your risk.
   
   
2. Flexibility: Imagine if you could buy and sell your market basket at any time during the day, adjusting to the ever-changing prices of the produce. ETFs offer you exactly this kind of flexibility. Unlike mutual funds, which only trade at the end of the day, ETFs can be bought and sold throughout the day, just like individual stocks.
   
   
3. Accessibility: Remember the FTSE 100 and S&P 500 we talked about earlier? Individually purchasing stocks from each company on these indexes could be a herculean task. ETFs, on the other hand, offer an accessible route to invest in these indices. It is like getting a taste of the most tempting produce at the market without needing to visit every stall.
   
   
4. Cost-effectiveness: Building your own diverse portfolio can lead to significant transaction costs, as you would be charged for every individual stock you buy or sell. However, with an ETF, you get diversity in a single transaction. This is much like saving on multiple transaction fees at the farmer’s market by buying the pre-packed basket instead of each item separately.
   
   
5. Choice: Whether you have a sweet tooth for tech stocks, a craving for commodities, or an appetite for international assets, there’s an ETF out there to suit your taste. And for those who prefer a health-conscious balanced diet, there are even ETFs that mix various asset classes!

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In essence, investing in ETFs is like shopping at the farmer’s market with a discerning eye, a constrained budget, and a big appetite. You get to sample a wide variety of assets, have the flexibility to adjust your investment, and can access far-reaching markets cost-effectively. What’s not to love about this financial smorgasbord?

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Heading back to our bustling farmer’s market, let’s consider two different ways to sample the produce. You could pick up our pre-packed basket (our ETF) that you can buy or sell at any time during the day. Or you could join a daily harvest program (an index fund) where you pay in the morning and receive a similar basket of varied produce at the end of the day. Both baskets offer a wide variety of goods, but the way you buy, sell, and receive them differs. This is quite like the choice between ETFs and index funds in the investment world.

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1. Trading Flexibility: As we’ve already discussed, ETFs are like our pre-packed baskets at the farmer’s market—you can buy or sell them throughout the day at fluctuating prices. This is similar to trading individual stocks and allows you to react quickly to market movements. On the other hand, index funds, much like the daily harvest program, only allow you to buy or sell at the end of the trading day, at a price determined after the market closes.
   
   
2. Investment Minimums: Joining the daily harvest program (our index fund) might require a significant minimum investment—you might need to commit to a whole season. ETFs, however, allow you to buy even a single ‘basket’. This makes ETFs a more accessible option for those just starting their investment journey or those with less capital to invest.
   
   
3. Costs: When it comes to costs, both our market basket (ETF) and daily harvest program (index fund) have their pros and cons. ETFs can sometimes have lower expense ratios (the cost to operate and manage the fund) than index funds. Plus, they offer the cost advantage of not requiring you to buy every stock separately. However, since ETFs trade like stocks, you might have to pay a commission each time you buy or sell, especially if you’re trading frequently.
   
   On the flip side, index funds, while sometimes having higher expense ratios, can often be bought or sold without transaction fees. Remember, though, some index funds require a significant initial investment, which might not be the case with ETFs.

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4. Dividend Treatment: Both our ETF and index fund ‘baskets’ might contain dividend-paying ‘produce’. With ETFs, dividends are usually paid directly to investors, much like a vendor at the market giving you a small bonus apple. With index funds, dividends are typically reinvested automatically, akin to receiving an additional share of the harvest instead of that bonus apple, or distributed directly to investors.

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Choosing between an ETF and an index fund is like choosing between our farmer’s market basket and daily harvest program. The right choice depends on your individual needs and circumstances, whether that’s the flexibility to trade throughout the day, a lower initial investment, cost considerations, or how you’d like to receive dividends. Each offers a way to sample the whole market. Your choice boils down to how you prefer to take your financial bite of that delicious investment pie.

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Choosing the right ETFs can be a daunting task, especially with the vast array of options available in the UK market. ETFs are known for their simplicity, diversification, and cost-effectiveness, which makes them a popular choice among investors.

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To help you make an informed decision, we have outlined some key factors to consider when choosing ETFs in the UK:

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1. Investment Goals and Risk Tolerance: First and foremost, it is essential to establish your investment goals and risk tolerance. Are you looking to achieve long-term growth, income, or a combination of both?
   
   Your investment horizon and the level of risk you’re comfortable with should guide your selection process. For instance, conservative investors might opt for ETFs focused on stable, income-generating assets, while aggressive investors may gravitate towards high-growth or niche sectors.
   
   

2. Diversification: One of the main advantages of investing in ETFs is the diversification they offer. A well-diversified portfolio can help reduce overall risk by spreading investments across various asset classes, sectors, and geographic regions.
   
   When choosing an ETF, consider its underlying holdings and ensure they align with your diversification goals. For example, a global equity ETF can provide exposure to numerous international markets, while a sector-specific ETF will focus on a particular industry.

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3. Costs: Costs are a crucial factor when selecting an ETF, as they can significantly impact your overall returns. Two primary costs associated with ETFs are the expense ratio and transaction fees.
   
   The expense ratio is an annual fee expressed as a percentage of the fund’s total assets, while transaction fees are charged when you buy or sell an ETF. Look for ETFs with low expense ratios, and be aware of any transaction fees imposed by your broker.

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4. Performance and Tracking Error: While past performance does not guarantee future results, it can give you an idea of how an ETF has fared over time. Examine the historical returns of the ETFs you’re considering and compare them to their benchmarks.
   
   Additionally, check the tracking error, which measures the difference between the ETF’s performance and that of its underlying index. A lower tracking error indicates a more accurate replication of the index’s performance.

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5. Liquidity: Liquidity refers to the ease with which an investment can be bought or sold without significantly impacting its price. In the context of ETFs, liquidity is determined by the trading volume of the fund and the liquidity of its underlying assets.
   
   A highly liquid ETF allows for efficient buying and selling, whereas a less liquid ETF may be more difficult to trade and could result in higher transaction costs. Look for ETFs with ample liquidity to ensure smooth trading.

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6. Fund Provider: Finally, consider the reputation and expertise of the ETF provider. Established providers with a proven track record can offer more confidence in the fund’s management and overall stability.
   
   It is also worth noting that larger providers may have more resources to keep costs low and provide a broader range of investment options.

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There are two ways to build a portfolio of ETFs. The first is by creating your own version of Bogleheads’ three-fund portfolio, and the second is by simply investing in an ETF that tracks the whole world.

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1. Three-Fund Portfolio

A three-fund portfolio is a simple passive investing strategy that involves investing in three types of ETFs or index funds with a long-term horizon of at least 20 years.

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The three funds are typically:

1. A domestic stock “total market” ETF,
2. An international stock “total market” ETF, and 
3. A bond “total market” ETF.

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Here is an example of how this could look in practice:

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Fund 1 could be an ETF that tracks the local UK market, i.e. a fund that tracks the FTSE UK All Share Index.

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Fund 2 could be an ETF that tracks the global market (developed world + emerging market) or US “total” stock market. For example, a fund tracking the S&P 500 Index.

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Fund 3 could be an ETF that tracks the performance of UK government bond indices such as the Bloomberg UK Government Inflation-Linked Float Adjusted Bond Index. 

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Here is a list of some of the best ETFs and index funds in the UK to get you started.

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Once you’ve chosen your ETFs, you have to adjust the allocation of each fund based on your risk tolerance. For instance, a risk-averse investor might hold a portfolio heavily tilted toward bonds. Similarly, someone bullish on the US or an emerging market like China might hold a portfolio that disproportionately favours a US or global ETF. Finally, if you would like a great deal of “home stocks” in your portfolio, you might allocate the largest portion of your portfolio to the UK ETFs.

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Other factors to consider when building an ETF portfolio include your current age and how long you plan to hold the ETFs. You should also consider the previous performance of each ETF while keeping in mind that past performance is not a reliable indicator of future results.

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The Bogleheads’ three-fund portfolio was originally created by Bogleheads in America.

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2. Global or “Whole World” index fund Portfolio

If you are the kind of investor who would prefer a single ETF to set and forget rather than invest in multiple ETFs, a global index tracker ETF might be a good choice for you.

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Global index tracker ETFs track the performance of companies worldwide, ranging from developed countries to emerging markets.

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When you buy an ETF that tracks a global market, you gain exposure to companies in the US, the UK, other developed countries, and even emerging markets like Latin American countries. Global index trackers are an excellent choice for people who want a highly diversified portfolio without limiting themselves to the domestic and US markets.

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We’ve put together a list of some of the best global ETFs, available via the best online brokers for UK index funds.

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Our vibrant farmer’s market, brimming with all its diverse and delightful produce, has served us well so far in explaining ETFs. But like any marketplace, it comes with its advantages and drawbacks. Let’s use it once more to delve into the pros and cons of ETFs.

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Pros of Investing in ETFs:

1. Diversification: The wide variety in our pre-packed market basket is one of the biggest advantages of ETFs. Just as your food basket includes a mix of different fruits and vegetables, ETFs contain a variety of assets—stocks, bonds, commodities, or a blend of these. This allows you to spread your investment risk rather than being dependent on the performance of a single asset.

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2. Flexibility: Like the ability to buy or sell your market basket throughout the day, ETFs can be traded at any time during market hours. This flexibility allows investors to react to market movements in real-time, unlike mutual funds that only trade at the end of the day.

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3. Lower Costs: Opting for a pre-packed basket at our market instead of buying each item separately saves time and effort. Similarly, ETFs generally have lower expense ratios compared to mutual funds and allow you to own a diverse portfolio in one transaction, thereby potentially reducing trading costs.

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Cons of Investing in ETFs:

1. Trading Costs: While the ETF basket might be cheaper than buying each item separately, every time you buy or sell that basket, there could be a commission fee—just like a transaction fee at the market. If you’re a frequent trader, these costs could add up.
   
   
2. Liquidity: Some types of produce in our market basket might not be as popular or widely traded, making them harder to sell. Similarly, some ETFs that focus on niche or less popular markets may not be as liquid. This could make buying or selling these ETFs more challenging and potentially impact the price you pay or receive when you trade.
   
   
3. Potential Tracking Error: Sometimes, our market basket may not perfectly reflect the entire farmer’s market’s variety. Similarly, an ETF might not perfectly track its underlying index due to various factors like fees or the fund’s management approach. This is known as a tracking error, and it can lead to the ETF’s performance deviating from the index it is trying to replicate.
   
   

All things considered, like our mixed basket at the farmer’s market, ETFs offer a variety of advantages such as diversification, trading flexibility, and potentially lower costs. However, potential drawbacks like trading costs, liquidity issues, and tracking errors are akin to the occasional overripe fruit in the basket. Understanding these pros and cons can help you make informed decisions when adding ETFs to your financial meal plan.

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Let’s delve into some common ETF fees you might encounter. The specifics of an ETF’s charges can always be found in its Key Investor Information Document (KIID).

Pro Tip: Fixed fees tend to work out cheaper for people investing high amounts, while percentage-based fees can be more cost-effective for those with less to invest.

Here’s a breakdown of the fees you typically pay when investing in ETFs in the UK:

1. Annual Management Fee: This fee, also known as the ongoing charges figure (OCF) or total expense ratio (TER), is paid directly to the ETF manager overseeing your chosen ETF. Say you’ve chosen three different ETFs; you’ll pay a management fee for each.
   
   
2. Annual Platform Fee: Also referred to as a custody fee, this is levied by the investment provider or trading platform facilitating your investment. It is typically a percentage of the total value of your portfolio or a fixed amount.
   
   
3. Market Spread: Also called the transaction cost, the market spread is the gap between the buying and selling prices of an asset, such as an ETF.
   
   
4. Trading Fee: The trading fee, or dealing fee, covers the cost of buying and selling investments like ETFs. While many platforms don’t charge a dealing fee for trading ETFs, those that do typically ask for an amount between £0.01 to £25.
   
   
5. Transfer-Out Fee: Also known as an exit fee, this is charged when you move your investments from one provider to another. Not all platforms impose an exit fee, but those that do usually charge per ETF or holding.
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6. Advice Fee: This fee is only applicable if you decide to seek financial advice. Remember, investing should align with your financial goals, and sometimes, professional guidance can be invaluable.

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To buy ETFs in the UK, you’ll need to:

1. Create an account with an investment platform, such as InvestEngine or Interactive Investor.
2. Verify your details and fund your account using a debit card or via bank transfer.
3. Choose a tax wrapper, such as an ISA or SIPP.
4. Research ETFs.
5. Create an investment strategy, such as the Bogleheads’ three-fund portfolio.
6. Choose and invest in your preferred ETFs using the platform’s web or mobile app.
7. Invest small amounts regularly to take advantage of pound-cost averaging.
8. Monitor your portfolio and rebalance when necessary.

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An S&P 500 ETF can be a good investment, especially for those looking for broad exposure to the large-cap equities market in the US. It is diversified across 500 of the largest US companies, reducing individual company risk. However, as with any investment, you should consider their risk tolerance, investment goals, and market conditions.

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Here are the top 10 UK ETFs to invest in, along with their respective ongoing charges figure (OCF):

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1. Vanguard S&P 500 UCITS ETF - 0.07%
2. iShares Dow Jones Industrial Average UCITS ETF - 0.33%
3. iShares NASDAQ 100 UCITS ETF - 0.33%
4. iShares Core FTSE 100 UCITS ETF  - 0.07%
5. iShares £ Index-Linked Gilts UCITS ETF - 0.10%
6. Vanguard FTSE 250 UCITS ETF - 0.10%
7. iShares Core MSCI Emerging Market IMI UCITS ETF - 0.18%
8. Vanguard FTSE All World UCITS ETF - 0.22%
9. iShares Physical Gold ETC - 0.12%
10. BlackRock ESG Multi-Asset Moderate Portfolio UCITS ETF - 0.25%

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To view the comprehensive list, see Best ETFs in the UK.

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ETFs can be an excellent choice for beginner investors due to their diversification, lower costs compared to many mutual funds, and ease of trading. They offer a simple way to gain exposure to a wide range of assets, sectors, or regions, reducing the need for extensive individual stock research.

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The number of ETFs a beginner should own varies based on individual financial goals, risk tolerance, and investment size. However, a diversified portfolio can often be achieved with as few as three to five different ETFs that cover different asset classes and sectors.

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The amount to invest in an ETF for the first time depends on your financial situation and investment goal. Some brokerages allow investors to purchase ETFs for the price of one share, which could be as low as £50 to £100. Others, such as InvestEngine or Freetrade, offer fractional ETF investing or a monthly savings plan which allows you to invest as little as £10 into your choice of ETFs every month. Remember, when it comes to investing, it is crucial to invest only what you can afford to lose.

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The frequency of investing in an ETF depends on your investment strategy. Some investors prefer a “buy and hold” strategy, investing a lump sum and letting it grow over time. Others might opt for a “pound-cost averaging” strategy, consistently investing a fixed amount at regular intervals, regardless of the ETF’s price.

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In the UK, any gains from ETFs are potentially subject to Capital Gains Tax, and dividends may be subject to Income Tax. However, if held within a tax-efficient wrapper like an ISA or a SIPP, gains and income from ETFs can be tax-free. Always consult a tax adviser for your specific situation.

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You can buy ETFs in the UK from the following ETF brokers:

1. XTB - 0% Commission on real stocks and ETFs; 350+ ETFs
2. InvestEngine - Low cost; 500+ Commission-free ETFs
3. Interactive Investor - One free trade per month; 40,000+ Instruments
4. Freetrade - Low cost; 250+ Commission-free ETFs
5. eToro - 0% Commission on real stocks; 250+ ETF CFDs
6. AJ Bell - Low cost; 3,000+ ETFs
7. Hargreaves Lansdown - Lots of investment options, research and tips
8. Vanguard - Low cost; 70+ Funds

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Yes, many ETFs do pay dividends. They are typically paid out to investors from the income received from the underlying assets. These can be either distributed (paid out to the investor) or accumulated (reinvested back into the ETF), depending on the type of ETF. Always check the dividend policy of an ETF before investing.

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Credits

1. Bogleheads
2. GOV.UK

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