How to choose the best ETFs for your investment playlist
November 22, 2022

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If you’ve already been dipping your toes into the investing waters, you’re likely to have come across ETFs (exchange-traded funds). For potential investors who’ve never heard of an ETF, you’re in for a treat.

ETFs are readymade baskets of stocks or other assets that investors can buy and sell on the stock market. The ‘readymade’ element means they’re often thought of as one of the best investments for beginners, but they aren’t just for newbies. 

In fact, investors of all levels have warmed to the idea of investing through ETFs over the past few years, so it’s worth being aware of how they might fit into your portfolio too.

With an ETF, you can invest in just about every asset class and mainstream equity market available, and even some alternative indices. They’re also usually a cheaper option than many types of active funds, such as mutual funds and closed-end funds like investment trusts, but that’s not a hard and fast rule. We’ll get into that further down the page, but first, let’s lay the foundations.

What is an exchange-traded fund?

ETFs (exchange-traded funds) are investments that trade on stock exchanges. This means you can buy or sell them the same way you would with a stock, through a brokerage or share dealing account.

As we’ve said, ETFs operate like an umbrella fund, holding a variety of investments beneath an overarching cover. It’s this one-stop shop idea of being able to get access to a lot of assets at once that’s a big draw for investors.

An ETF can be managed passively, where it’s set up to track a broad index like the S&P 500. Alternatively, it can be actively managed, where a team of experts will construct an index for the ETF to track.

The latter is more common for ETFs exploring themes like robotics, biotech, or cybersecurity, where there isn’t necessarily a natural index out there for it to track.

The type of asset classes held within the funds can range from popular ETFs that are equity-based - like the iShares Core S&P 500 UCITS ETF (GSPX), to an ETF that invests in fixed-income assets like the iShares $ Ultrashort Bond UCITS ETF Dist. (ERNU).

It used to be that the simple index-tracking ETFs out there were the nemesis of the actively managed open-ended fund, with a human manager at the helm. While ETFs just tried to match a market’s performance and charge a pittance for doing so, city stock pickers charged more and tried to beat the index instead. 

The fact that they couldn’t consistently do so has been a big factor in that money flowing into passive ETFs instead. Although, with active ETFs honing in on specific sectors and raising their prices for these less common strategies, the line between the two approaches is blurrier than ever.

How big is the ETF market?

ETFs come in all shapes and sizes. There are over 8,000 globally, holding more than $10tn worldwide, according to Statista. 

The choice for investors has never been greater, but the other edge of that sword is that the range of options available can feel overwhelming. Many are very similar to each other, tracking the same markets or indices, which can further confuse investors who are just starting out.

Here’s how the number of ETFs available has blossomed over the last 10 years:

Can I buy US ETFs in the UK?

It’s definitely possible to buy a UK ETF that tracks US markets. There are loads of options available from many of the biggest investment companies in the world. However, buying US-based ETFs isn’t an option for the majority of UK investors. 

You may feel hard done by with this, but it’s not necessarily a bad thing. US ETFs fall under different rules and regulations than the ones available to you here in the UK. The major difference is that US ETFs don’t provide investors with a KID (key information document), previously known as a KIID (key investor information document). 

Unlike a screaming toddler, this KID is pretty useful. It outlines important information relating to an ETF, allowing you to better compare them and make more informed investing decisions. So, the lack of US ETFs providing this disqualifies the majority of American exchange-traded funds from being listed on UK and European stock exchanges.

In the UK, most ETF investments fall under a regulatory framework set out by an EU directive called ‘UCITS legislation’.  

UCITS stands for ‘undertaking for collective investment in transferable securities’. A mouthful for sure, but it’s why you’ll often see the phrase ‘UCITS ETF’ at the end of each investment. 

It sets out rules for the ways in which ETFs have to be managed and marketed, which at the end of the day protects you as an investor. Thankfully, the UCITS ETF framework is something that has stuck around post-Brexit.

How do ETFs work?

An ETF is a type of security that usually contains a bundle of assets and typically tracks a stock index or industry benchmark. 

ETFs operate in a very similar way to index funds, tracking the performance of groups of individual stocks, whole country equity markets, or even a representation of global stock markets, like the MSCI World Index.

ETFs created by companies are open-ended funds which is a similarity they have with mutual funds. It’s also something that separates them from investment trusts, which are closed-ended funds.

The basic difference is that with open-ended investment companies, an unlimited number of new shares can be created on a daily basis. When people buy, the fund simply creates new shares to give them, and when they sell, the fund reduces the share count. Whereas, closed-ended funds have a fixed number of shares. A major benefit of open-ended funds is liquidity. It’s always possible to buy or sell your ETF shares on stock exchanges.

To that extent, ETFs are a bit of a hybrid in that they are listed but act like an open-ended fund.

Share prices of an ETF will depend on the future performance of the financial instruments or individual stocks being held in the ETF basket. Some examples of the various types of ETFs you can invest in include:

  • Passive funds tracking major stocks or equity markets.
  • ETFs that invest in individual stocks within a particular sector, or perhaps socially responsible ESG ETFs for alternative income.
  • ETFs that track lesser-known, alternative indices.
  • Active ETF funds that are managed by teams or individuals.
  • Exchange-traded funds focusing on dividends, corporate or government bonds, currencies, and even commodities.

The possibilities with ETFs are fairly limitless. But if you want to find the best long-term stocks, it’s important to find the right ETFs that suit your long-term investing strategy, time horizon, and most importantly, your investment risk appetite.

What do ETFs cost?

It can vary depending on the ETF in question. In theory, most index-linked ETFs should be relatively cheap, but this isn’t always the case.

The main ETF costs to consider are:

  • Expense ratios - usually shown as TER (total expense ratio).
  • Brokerage fees or commissions - for ETF stock trading.
  • Currency conversions - FX charges.
  • Potential tax costs - if you’re holding your ETF outside a tax wrapper such as a stocks and shares ISA or a SIPP.

When you start researching an ETF you want to buy, you’ll notice a total expense ratio (TER), usually presented as a percentage in the KID. This is also sometimes called the ‘ongoing charges figure’ or OCF for short. Apologies for all the acronyms just thrown your way, there are a fair few to digest and wrap your head around.

Typically, passive exchange-traded funds tracking major indices tend to have a lower total expense ratio. On the other side of that coin, actively managed ETFs, or those investing in alternative indices, often come with higher costs. This is partly due to economies of scale. The more popular ETFs attract more investors, allowing them to be more cost-efficient. 

How much your ETF costs to buy or sell will also depend on your investment account. For example, with Freetrade, there’s no commission for buying or selling UK ETFs although other charges like foreign exchange fees might apply. But, other brokerages may not offer this benefit. Some will charge a flat fee for trading ETFs and others will charge you a percentage fee based on the size of your trade. 

How can I invest in ETFs in the UK?

If you’ve considered the investment risks and weighed them up against the potential benefits of investing in ETFs, here’s a straightforward step-by-step guide explaining how to invest:

  1. Compare brokerage accounts to decide which one best suits your investing platform needs. Our investment fees calculator will help you understand the charges you could face.
  2. Open a stocks and shares investment account with your broker of choice. You might want to factor in tax efficiencies here. Think about whether a GIA, stocks and shares ISA or SIPP could help. Once you’ve decided, make your first deposit.
  3. Research the type of ETF you want to invest in. That could mean one that’s passive or actively managed, a broad stock market ETF, or perhaps an exchange-traded fund based on alternative indices.
  4. Make sure the ETF fits in with your overall investment strategy, diversification plans, and that the rest of your finances are in a healthy position.
  5. Select how many ETF shares you want to buy. You can buy fractional shares on the Freetrade app for US shares. Just remember, if you want to buy an ETF tracking the US stock market it’ll likely be UK-listed, as US ETFs don’t satisfy UK KID requirements for retail investors.

Whichever way you decide to invest in ETFs, keep in mind that they don’t always provide complete portfolio diversification.

There are a number of additional risks to consider such as systemic sector risk, country-specific risks, misleading ETF titles, exposure to volatile commodities, and potential tax implications (depending on the type of ETF).

Read more: investment risk explained

Exchange-traded funds vary widely and they’re not a foolproof way to become a successful investor. And with many, there’s not even a possibility of outperforming the market because they’re only designed to track it, not beat it.

What are the top 10 ETFs to buy?

Deciding the top or ‘best’ ETFs can be subjective. Because, if you were to look at something like share price performance, it would depend on the timeframe you’re looking at. 

It’s also important to realise that each ETF will have its own objective, some may aim to mirror companies with capital growth potential, whereas the purpose of others might be income investing for dividends, or concentrating on fixed-income assets like bonds.

So, judging the best ETFs can be a matter of interpretation. That’s why we look at the most popular ETFs instead, because this will cover a cross-section of investors and show you what others deem to be the best, by voting with their money.

To give you some insight, here are 10 of the most popular ETFs on the Freetrade app:

ETF Ticker Description
Vanguard S&P 500 UCITS ETF (Dist.) VUSA This US stock market ETF invests in some of the 500 largest American companies. It has a comparatively low ongoing charge, and income is distributed as cash into your account.
iShares Global Clean Energy UCITS ETF (Dist.) INRG Although not technically an ESG UCITS ETF, this passive fund tracks a global index of sustainable and renewable firms from the S&P Global Clean Energy Index. The fund pays out dividend income as cash.
Vanguard S&P 500 UCITS ETF USD (Acc.) VUAG This ETF is very similar to the other Vanguard S&P 500 ETF, except for the fact that income and dividends are automatically reinvested back into the fund. It also has a low expense ratio compared to other equity market exchange-traded funds.
iShares Core FTSE 100 UCITS ETF (Dist.) ISF This ETF tracks the top hundred large-cap companies in the UK stock market. It’s a passive fund that distributes dividends as cash. If you want your portfolio to be tax-efficient, here’s what you need to know about stocks and shares ISAs and dividends.
Vanguard FTSE All-World UCITS ETF (Dist.) VWRL A global stock market ETF with well over 3,000 holdings, this passive fund tracks the performance of the All-World Index. It’s made up of both mid-cap and large-cap stocks in developed and emerging markets and pays out any income directly, without rolling it back into the fund.
iShares UK Dividend UCITS ETF (Dist.) IUKD This UK dividend ETF tracks and invests in UK-based companies from amongst the top 350 with high dividend yields. These dividends are paid out as cash into your investment account.
iShares S&P 500 UCITS ETF (Dist.) IUSA Here’s another popular S&P 500 ETF, but this time from a different brand. The iShares S&P 500 ETF is currently one of the cheapest US stock market funds available in terms of its total expense ratio (TER), and it distributes income as cash.
Invesco NASDAQ 100 UCITS ETF (Dist.) EQQQ This ETF concentrates on investing in tech stocks and tracks 100 of the top NASDAQ-listed technology companies. It distributes dividends as cash.
Vanguard FTSE All-World UCITS ETF USD (Acc.) VWRP This ETF is nearly a carbon copy of the other Vanguard All-World ETF, tracking the global equity market. The only difference is that income is rolled back into the fund automatically instead of being distributed.
iShares Core S&P 500 UCITS ETF (Dist.) GSPX This ETF tracks 500 of the largest US companies based on the S&P 500 index and it distributes any dividends generated as cash.

Source: Freetrade, 2021.

Which is the best UK market ETF?

As mentioned, selecting the best ETF isn’t an exact science. If you are looking for the best UK ETF that simply tracks a major stock market index, it’s worth remembering that many ETFs will be very similar, but with different branding.

Some top UK ETFs will also have different total expense ratios. So, it’s usually worth making sure you’re not paying more than you need to in terms of ongoing annual charges, because a passive tracker ETF should be on the lower end of the expense scale. 

To give you some perspective, here are five of the largest stock market ETFs based on fund size and assets under management (AUM) as of November 2022:

  1. Vanguard FTSE All-World UCITS ETF (VWRP/VWRL) - $13.43bn
  2. iShares Core FTSE 100 UCITS ETF (ISF/CUKX) - £10.28bn
  3. Vanguard FTSE 100 UCITS ETF (VUKE/VUKG) - £4.33bn
  4. Vanguard FTSE All-World High Dividend Yield UCITS ETF Dist. (VHYL) - $3.09bn 
  5. Vanguard FTSE Developed Europe UCITS Dist. (VEUR) - €2.66bn

Remember, if you’re looking for the best UK ETFs, the share dealing platform you’re using or stocks and shares ISA rules might also limit your choice. 

What is the best S&P 500 ETF available in the UK?

All S&P 500 ETFs should be tracking the same index and pretty much contain the exact same investments. So, the returns should be similar. 

Often it’s cost that’s the big differentiator. You should also keep in mind that ETFs with ’S&P’ in the title have to pay royalties. Some companies get around this by naming their ETF something along the lines of "America’s Top 500’’, but they essentially still just mirror the S&P index. 

Here are some of the biggest S&P 500 UCITS ETFs based on fund size and AUM as of November 2022:

  1. iShares Core S&P 500 UCITS ETF (GSPX for distributed dividends/CSP1 for accumulating dividends) - $53.43bn
  2. Vanguard S&P 500 UCITS ETF (VUSA for distributed dividends/VUAG for accumulating dividends) - $33.03bn 
  3. Invesco S&P 500 UCITS ETF (SPXP) - $14.14bn
  4. iShares S&P 500 UCITS ETF USD Dist. (IUSA) - $11.82bn
  5. HSBC S&P 500 UCITS ETF GBP Dist. (HSPX) - $4.44bn

How many ETFs should I invest in as a beginner?

It really depends on your investing goals.

If for example you research how to invest £1,000 and decide that an equity market ETF is the path you want to go down, a good place to start might be a global fund that tracks the MSCI World Index.

Or, you may want to keep your investments at home and opt for a UK stock market ETF that would typically aim for slow and steady growth, with dividends playing a big role. Looking across the pond, you may also choose to invest in something broad like an S&P 500 ETF. These investment strategies can be a good place to start whether you want to invest £10,000 or just £1.

Also, you can always create a portfolio containing a combination of ETFs. When you’re finding your feet, it can be worthwhile keeping things as simple and straightforward as possible, and then expanding from there as your knowledge grows and you become more comfortable with stock market investing. 

But the truth is, the right number of ETFs to hold will be a completely personal decision that you need to make for yourself. Or, seek some professional advice from a financial adviser if you’re really unsure.

How many ETFs should I own?

This is totally down to personal investment strategies. Some potential investors like the idea of holding a single, broad stock market ETF, and others will be looking for a mixture.

Another popular strategy is to hold a few passive funds at the core of your portfolio and then pick individual stocks or active funds to round out your holdings.

There are so many possibilities and what’s most important is that you’re using these exchange-traded funds in the best way to suit your personal investing needs. 

Again, if you’re ever unsure about picking investments, a chat with a qualified financial adviser could be worthwhile.  

What is the safest ETF to invest in?

We all want healthy returns with as little risk as possible. That’s natural, if a little greedy. We always have to be prepared to adopt risk in the stock market in the pursuit of returns.

That said, if capital preservation or minimising volatility are the goal, there are ETFs to suit. Not least the ones with ‘minimal volatility’ in the name like iShares Minimum Volatility (MVEW).

For less active equity investments, this will often be the broader type of ETFs. For example, ETFs that cover stock markets in developed countries, or possibly a global equity market ETF that tracks the MSCI World Index. Outside of broad, stock market equity ETFs, other potential options for lower volatility include:

  • Gilts or government bond ETFs.
  • Dividend ETFs.

But, each type of ETF will still carry its own risks and downsides. For example, previously a bond UCITS ETF could have provided a good balance to equity market ETFs, because bond markets and stock markets should move in opposite directions.

Yet recently, performance figures of bonds have also underperformed in-step with equities. This has  been dubbed a ‘once in a hundred year’ and ‘black swan’ event, but it just goes to show there are no guarantees or completely safe ways to invest, especially if you’re looking at a short timeframe. 

Do ETFs fail?

It is possible for ETFs to be shut down if they’re unpopular. Complete failure is quite rare, but not impossible.

ETFs focused on one particular sector or industry can be hit badly and suffer because of their heightened exposure to a given theme. Yet, it’s unlikely that the share prices of every investment in an ETF would go to zero. 

Typically, the more broad and diverse the ETF, the less chance you’ll see massive performance failures, but you’re also less likely to see outsized gains. 

If you were investing in a global ETF or an S&P 500 ETF, you’d either need the global economy or the American economy to fully collapse for one of these ETFs to fail. 

So, while getting back less than what you put in is possible, total failure for certain ETFs is extremely unlikely. But, who knows? Crazy things have happened throughout history. However, if global stock markets get wiped out, you’ve probably got bigger issues to worry about than the future performance of your portfolio. 

Are ETFs a good investment?

They definitely can play a useful part in your portfolio, but it’s still worth being aware of the downsides when weighing up ETF investment strategies. 

If you invest in ETFs covering international stock markets, bear in mind that things like currency fluctuations have the potential to impact future performance and your overall returns.

Also, if you’re buying passive exchange-traded funds on stock exchanges that only track the performance of stock markets, by design you’re never going to outperform the market like you potentially could with individual stocks.

At the end of the day, the right financial instrument for you to use, whether that’s a UCITS ETF, or something completely different, will be a decision you have to make based on your personal situation and financial goals.

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Important information

When you invest, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you invest.

Freetrade does not give investment advice and you are responsible for making your own investment decisions. If you are unsure about what is right for you, you should seek independent advice.

Freetrade is a trading name of Freetrade Limited, which is a member firm of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales (no. 09797821).

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