What is an ETF and how does it work?
An ETF (Exchange-Traded Fund) is a basket of securities that tracks an index, like the S&P 500 or the MSCI World, and trades on stock exchanges just like an individual stock, unlike a traditional mutual fund that only settles at end-of-day prices.
The main advantage over actively managed funds is cost. While active funds often charge 1.5%-2.0% annually in management fees, passive index ETFs typically charge 0.05%-0.30%. Over 20 years, that fee gap can translate into tens of thousands of euros of difference in your final wealth, as we explain in detail in our guide to index funds vs. active management.
Practical example: the real impact of fees
Example. Two people each invest €300 a month for 25 years at the same 7% annual market return. The first uses an index ETF with a 0.15% TER, the second an active fund with a 1.75% TER. After 25 years, the first ends up with around €235,000; the second, with the exact same gross market return, ends up around €185,000. That €50,000 difference doesn't come from a better investment decision — it comes purely from the annual fee compounding over two and a half decades.
Main types of ETFs
ETFs exist for virtually every asset class: global equities, government or corporate bonds, commodities (gold), real estate (REITs), or thematic sectors.
- Global equity ETFs (e.g., MSCI World, MSCI ACWI): maximum diversification in a single position.
- Fixed income ETFs (e.g., Bloomberg Global Aggregate): lower volatility, lower expected returns.
- Commodity ETFs (e.g., physical gold): partial hedge against inflation or macro instability.
- Sector or thematic ETFs: concentrated exposure to specific industries, not recommended as the core of a diversified portfolio.
Costs and taxation of ETFs
The primary ongoing cost of an ETF is its TER (Total Expense Ratio), automatically deducted from the fund's net asset value day by day, without you having to do anything. Since ETFs trade on exchanges, you may also pay a brokerage commission per trade, unlike traditional mutual funds.
Tax treatment on capital gains varies by country, so check the rules that apply to you. Unlike traditional mutual funds in some jurisdictions, switching between ETFs is generally a taxable event, since each sale realizes a gain or loss.
Risks you should actually know about
ETFs are strictly regulated and their assets are legally segregated from the issuer's own balance sheet: you can't lose your investment because the issuer goes bankrupt. But that doesn't remove market risk, which remains exactly the same as with any equity or bond investment.
A lesser-known risk is liquidity in very small or niche ETFs: low trading volume can widen the gap between buy and sell prices, making the trade more expensive. For the core of a portfolio, it's better to prioritize large, heavily traded ETFs over exotic, low-volume products.
How to start investing in ETFs
Open an account with a broker that offers ETFs with low, transparent fees. Define your risk profile and time horizon before choosing any specific product. For most individual investors, a global ETF (MSCI World or similar) is an excellent starting point, with no need to overcomplicate the portfolio from day one.
The key isn't picking the perfect ETF, but starting, staying consistent, and keeping costs low for decades. Connect your investments to your net worth to see their real impact on your whole balance sheet, instead of looking at them in isolation.
It's no accident that Warren Buffett, probably history's most successful investor, has repeatedly recommended this exact strategy (a low-cost global index ETF, held for decades) to the vast majority of individual investors who don't have his time or professional analytical ability.
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Frequently Asked Questions
Both track indices passively, but traditional index funds often allow tax-deferred switches in some jurisdictions, while ETFs usually have a slightly lower TER and more trading flexibility. For automated recurring contributions, a traditional index fund is often more convenient.
You can start with the price of a single share, which varies by ETF (from around €5 to over €400). Some brokers also allow fractional share purchases, lowering the entry barrier further.
ETFs are regulated and their assets are segregated from the manager's own assets, so you can't lose your investment because the issuer goes bankrupt. But if the market falls, your ETF's value falls too: don't confuse legal safety with an absence of market risk.
A physically replicating ETF actually buys the assets of the index it tracks. A synthetically replicating one uses financial derivatives to replicate the performance without directly owning the assets. Physical replication is usually simpler to understand and the preferred option for most individual investors.
For many investors, one or two global equity ETFs already offer very broad diversification across thousands of companies and countries. Adding many different ETFs doesn't always improve real diversification and can make tracking harder without added benefit.