Exchange-traded funds (ETFs) are one of the simplest and most cost-effective ways to invest. They let you buy a ready-made basket of investments, often for a fraction of the cost of picking individual shares.
But not all ETFs are the same. From broad index trackers to funds focused on specific sectors, themes or sustainability goals, there are different options depending on your interests and investing approach.
In this guide, we explain the main types of ETFs – index, sector, thematic and ESG – and how each one works.
What are index ETFs?
Let’s start with index ETFs. These are important to know about because many of the most popular ETFs globally are index ETFs.
In a nutshell, these are ETFs that track the performance of a specific index (or market) – that could be the S&P 500 in the UK or the UK’s FTSE 100.
So, if you wanted broad access to the biggest companies in the US, you’d likely opt for an S&P 500 ETF, which grabs you a small stake in all 500 companies on the list. The percentages of each company (we call these ‘weights’) might differ from ETF to ETF but, broadly speaking, this is how they work.
Why they’re popular
- Diversification. One fund gives you exposure to hundreds of companies.
- Low cost. Because they simply track an index, they’re usually among the cheapest ETFs available.
- Transparency. You always know which index the ETF is following.
What are sector ETFs?
Sector ETFs, as you might be able to guess, focus on a specific industry or sector. So, you might see healthcare ETFs, or AI ETFs.
Investors like them because you can actively invest in the industries that you think have the potential to grow. Or, you can invest in those that interest you.
By their nature, sector ETFs are less diversified than some other types, so they can be subject to a little more volatility. What they do offer is a flexibility and targeted approach that can be difficult to replicate without them.
Why they’re popular
- Targeted exposure. A way to invest in industries you believe will outperform.
- Tactical investing. They can be used to adjust your portfolio if you want more exposure to a certain sector.
What are thematic ETFs?
Thematic ETFs invest in themes or trends. These are similar to sector ETFs, with some subtle distinctions.
Where sector ETFs might give you access to established economic sectors like healthcare, thematic ETFs can be a little more forward looking and broad. So, you might invest in the theme of clean energy, AI, or healthcare innovation specifically.
Why they’re popular
- Global trends. They allow investors to back long-term global trends they’re interested in or believe will grow.
- Narrower focus. This means you can be more targeted in your investing, but this of course comes with its own risks.
- Growth potential. Some themes have high growth potential, for investors to back if they believe in it.
What are ESG ETFs?
ESG stands for Environmental, Social and Governance. ESG ETFs screen companies based on how they perform in these areas, aiming to combine returns with responsible investing.
These funds aim to combine ethical investing with returns, and they cover a vast array of industries, indexes and themes alongside their ESG considerations.
How these funds are screened can differ, so it’s worth doing a bit of research before you invest to ensure you’re investing in line with your values.
Why they’re popular
- Values-driven. They allow you to align your investments with sustainability goals.
- Broad exposure. They’re still diversified across many sectors and regions.
- Growing popularity. Increasing demand for sustainable options means more ETF choice.
How to choose between different types of ETFs
The different types of ETFs can cater for different styles of investing. Some considerations for what you’re targeting might be:
- Looking for broad long-term growth? Index ETFs could be a solid foundation. They cover broad indexes and by taking a few of these, investors can give themselves access to a vast portion of the global economy.
- Interested in specific industries? Sector ETFs provide targeted access. So, you can back industries that you think are in a position to grow.
- Want to back global trends? Thematic ETFs can help you invest in big ideas, with less rigid definitions than Sector ETFs. Believe in the future of AI in healthcare? This might be the type of ETF for you.
- Prefer sustainability? ESG ETFs let you align investments with your values.
With InvestEngine, you can explore all these types of ETFs in one place. Our platform offers:
- A vast selection. We have over 800 ETFs on our platform. This might sound daunting, but they’re laid out by theme and it’s easy to find what you’re looking for.
- No platform fees. InvestEngine charges absolutely no platform fees. You won’t pay commission, trading fees, or anything like that. Just the underlying ETF costs apply.
Effortless automation. Once you’re set up with a portfolio, you can fully automate your investing, from the initial bank transfer to reinvesting any returns.
Getting started with ETFs
ETFs are flexible, low-cost and transparent, making them a powerful tool for all kinds of investors. Whether you want broad market exposure, to focus on sectors or themes, or to invest with sustainability in mind, there’s an ETF to suit your strategy.
With InvestEngine, you can start investing in ETFs from as little as £100, choose a DIY portfolio, and use our automated tools to make investing effortless.
Explore our ETF portfolios today and see how they could help you grow your wealth.
FAQs
- What is an ETF and how does it work? An ETF (exchange-traded fund) is a type of investment fund traded on stock exchanges. ETFs let you invest in a ready-made basket of stocks, bonds or other assets, offering diversification and low costs compared to buying individual shares.
- What are index ETFs? Index ETFs are funds that track a specific stock market index such as the FTSE 100 or S&P 500. They give investors broad exposure to a market in one trade and are usually among the cheapest ETFs to invest in.
- How are sector ETFs different from index ETFs? Sector ETFs invest in companies from a single industry, such as healthcare ETFs or technology ETFs. Unlike index ETFs, they are less diversified but allow investors to target industries they believe will perform well.
- What are thematic ETFs and how do they work? Thematic ETFs focus on long-term global trends or investment themes, such as clean energy ETFs, AI ETFs, or robotics ETFs. They can be more volatile than index ETFs but allow investors to back ideas they believe in.
- What is an ESG ETF? An ESG ETF (Environmental, Social and Governance ETF) invests in companies screened for sustainability and ethical standards. They let you align your investments with responsible and sustainable investing goals.
- Which type of ETF is best for beginners? For many beginners, index ETFs are a good starting point because they’re diversified, low-cost, and easy to understand. However, the right choice depends on your goals, risk tolerance, and time horizon.
- Are ETFs risky to invest in? All investments carry risk, and ETFs are no exception. Index ETFs tend to be lower risk due to diversification, while sector ETFs and thematic ETFs can be more volatile. ESG ETFs vary depending on their underlying holdings.
- How do I choose between index, sector, thematic, and ESG ETFs? It depends on your investment goals: Index ETFs for broad, long-term growth, Sector ETFs for specific industries like tech or healthcare, Thematic ETFs for global trends such as AI or renewable energy, ESG ETFs for aligning investments with sustainability values.
- Can I mix different types of ETFs in my portfolio? Yes. Many investors combine index ETFs for stability with sector or thematic ETFs for growth and ESG ETFs for sustainability. Mixing ETFs helps build a diversified investment portfolio.
- How can I invest in ETFs with InvestEngine? With InvestEngine, you can invest in ETFs from as little as £1. Choose from over 800 ETFs with no platform fees, create your own DIY ETF portfolio, or pick a Managed portfolio with automated tools like AutoInvest and Savings Plans.
Important information
Capital at risk. The value of your investments may go down as well as up, and you may get back less than you invest.
Tax treatment depends on your personal circumstances and may change in future. This article is for general information only and does not constitute financial advice.
Past performance is not indicative of future performance. ETF costs also apply. If in doubt you may wish to consult a professional adviser for guidance.