Over the past decade, exchange traded funds (ETFs) have transformed how individuals and institutions invest. They’ve made it easier than ever to invest in a wide range of markets, often at a low cost, and while being able to see exactly what you’re investing in.
But for many investors, there’s still the question of how safe are ETFs?
ETFs are an efficient way to access markets. However, as with any investment, it’s important to understand what you’re buying, how it works, and what protections are in place.
What is an ETF?
An ETF is an investment fund that trades on a stock exchange, just like a share.
Most ETFs are designed to track the performance of a specific index, like the FTSE 100 (UK stocks), S&P 500 (US stocks), or the MSCI World (global stocks).
When you invest in an ETF, you’re buying a small piece of a fund that owns all (or most) of the investments in that index.
For example, a FTSE 100 ETF lets you invest in 100 of the UK’s largest listed companies.
ETFs give investors several key benefits:
- Diversification: One investment lets you invest in many companies or bonds.
- Low cost: Because so many ETFs aim to track an index rather than beat it, the fees are typically lower than those of actively-managed funds.
- Transparency: Most ETFs publish their holdings daily, so investors can see exactly what they own.
- Accessibility: Investors can buy and sell ETFs easily through InvestEngine with amounts as small as £1.
How do ETFs track an index?
ETFs use different replication methods to mirror the performance of the index they’re tracking. While this might sound technical, the idea is simple: to deliver the same return as the index it tracks.
There are three main ways ETFs will try match the index:
- Physical replication:
Where the ETF directly buys the underlying securities in the index. A physically replicated FTSE 100 ETF, for example, holds shares in all 100 companies. - Optimised or sampling replication:
For very large or complex indices (like global bond markets), it may not be practical to hold every single investment. These often own 1000s of underlying investments. In that case, the ETF buys a representative sample that closely matches the index’s performance. - Synthetic replication:
Some ETFs, especially those tracking commodities or emerging markets, use derivative contracts known as swaps to mirror returns.
These funds don’t hold the actual securities, but instead agree with a counterparty (often a bank) to deliver the index’s performance.
Synthetic ETFs can be useful in hard-to-access markets, but they introduce a small amount of counterparty risk (meaning the ETF depends on another institution to deliver its returns).
Regulations ensure that collateral is held to offset this risk and in some cases insurances against defaults are in place.
How safe are ETFs?
When considering how ‘safe’ an ETF is, it helps to separate the different types of risk involved:
1. Market risk
ETFs rise and fall with the markets they track. If the FTSE 100 falls, a FTSE 100 ETF will fall too. This is the same risk faced by any investor in shares, bonds and commodities.
2. Provider or firm risk
What happens if the company managing your ETF goes out of business?
In the UK and Europe, ETFs are structured so that fund assets are held separately from the provider’s own accounts.
Even if the issuer were to fail, your investments are ring-fenced and safeguarded by an independent custodian bank. This prevents ETF issuers from using client funds to run their own businesses.
3. Counterparty risk
For synthetic ETFs, the main additional risk is that the counterparty providing the swap could default.
To manage this, regulators require ETFs to hold collateral (typically a portfolio of high-quality investments) that can be used to protect investors.
4. Liquidity and trading risk
ETFs trade throughout the day like shares. For large, liquid ETFs, buying and selling is straightforward.
However, smaller and niche ETFs can have wider bid-offer spreads, meaning you may receive slightly less when selling or pay slightly more when buying.
“ETFs have transformed investing by offering full transparency, cost efficiency, and ease of investing in a single trade. They can be powerful tools that aim to allow all investors to access investing with flexibility, whether for long term growth or for tactical opportunities. As one of the world’s leading ETF providers, we have been pioneering innovative ETF solutions for investors since 2003 and now manage over US$1 trillion in ETFs and indexed strategies (as at 30 November 2025). We place a strong emphasis on managing risk, particularly within our market-leading synthetic ETF platform. We have a dedicated team that plays a critical role in supporting tradability of our ETFs, ensuring robust processes that help instill investor confidence in all types of market conditions.”
Tom Banks, Head of UK ETF Distribution, Invesco
What does the Financial Services Compensation Scheme (FSCS) cover?
One of the most common misconceptions among UK investors is that the Financial Services Compensation Scheme (FSCS) protects all investments.
In practice, the FSCS does not protect against investment losses. It only applies if a UK-regulated firm fails and is unable to return client assets.
Here’s what that means:
- Covered: If your investment platform (like InvestEngine), broker, or custodian goes bankrupt and cannot return your holdings, you may be entitled to compensation of up to £85,000 per person per firm.
- Not covered: If the ETF itself falls in value due to market movements, or if the index it tracks performs poorly, you are not protected under the FSCS.
It is also important to note that ETFs domiciled outside of the UK are not subject to FSCS protection at the fund level.
Importantly, ETFs themselves are separate legal entities. Even if the provider were to go out of business, the ETF’s assets are held independently and remain yours. Their assets are held independently by a custodian, meaning that the underlying assets of the fund remain ring-fenced and belong to the investors.
Built-in investor protections
ETFs available to UK investors are typically governed by UCITS regulations (a European framework designed to protect investors).
UCITS-compliant ETFs must follow strict rules on diversification, transparency, and risk management.
Some of the key protections include:
- Segregated assets: ETF holdings are kept entirely separate from the fund provider’s own accounts.
- Custodian oversight: An independent custodian (usually a large bank) safeguards the assets and ensures they’re properly managed.
- Daily pricing: ETFs are valued every day, allowing investors to see accurate prices and performance.
- Regulatory oversight: The Financial Conduct Authority (FCA) regulates ETF providers operating in the UK.
These safeguards make ETFs one of the most tightly regulated and transparent investment vehicles available.
Why ETFs are a powerful tool for investors
For new investors, ETFs offer a practical way to build a diversified portfolio without needing to pick individual shares or time the market.
They can be used to:
- Access global markets – from US technology to emerging economies.
- Gain exposure to themes – such as clean energy, robotics, healthcare innovation or blockchain.
- Build a core portfolio – using broad-market ETFs tracking global stocks or bonds.
- Invest efficiently – thanks to low costs and how easy it is to trade.
ETFs also work well within tax-efficient wrappers like ISAs and pensions (SIPPs).
Recent changes to ISA rules now allow for fractional investing, meaning you can own part of an ETF unit, helping investors start small and diversify quickly. Fractional trading is something InvestEngine has provided for years.
Learn more about fractional investing with InvestEngine
ETFs have grown rapidly for a reason: they combine diversification, low cost, and transparency in one simple product.
Whilst they’re not risk-free, their regulated structure and clear safeguards make them a sound choice for many investors.
The key takeaways
- Your assets are ring-fenced and held securely, even if the ETF provider fails.
- The FSCS protects against firm failure, not market losses.
- ETFs are one of the most efficient ways to build a diversified, long-term portfolio.
For UK investors starting their investment journey, understanding how ETFs work and what risks they carry, is the first step towards investing with confidence.
Explore ETFs with InvestEngine
FAQs on ETF safety
1. Are ETFs a safe investment in the UK? ETFs are considered one of the safest and most transparent investment products available. They are tightly regulated under the UCITS framework and overseen by the Financial Conduct Authority (FCA). While ETFs carry market risk like any investment, they offer strong safeguards such as segregated assets and independent custodians.
2. Can I lose money investing in ETFs? Yes. The value of your ETF can fall if the market or index it tracks declines. ETFs aim to replicate performance, not outperform it, so investors are exposed to the same market ups and downs. However, diversification across many assets helps reduce the impact of any single company or bond.
3. What happens if my ETF provider goes out of business? In the UK, your ETF investments are ring-fenced from the provider’s own funds and held by an independent custodian bank. Even if the provider fails, your assets remain protected and legally yours.
4. Are ETFs covered by the Financial Services Compensation Scheme (FSCS)? The FSCS only protects you if a regulated firm, such as your investment platform or custodian, fails and cannot return your assets. It does not protect against losses caused by market movements or poor investment performance.
5. What is the difference between physical and synthetic ETFs? A physical ETF holds the actual shares or bonds in the index it tracks. A synthetic ETF uses derivatives called swaps to replicate returns. Synthetic ETFs can help access harder-to-reach markets but involve small counterparty risk, which is tightly regulated and collateralised.
6. How do ETFs protect investors from counterparty risk? UCITS rules limit how much exposure an ETF can have to a single counterparty. Synthetic ETFs must hold collateral (typically high-quality bonds or securities) to offset any potential losses if the counterparty defaults.
7. Are ETFs liquid and easy to trade? Most ETFs are highly liquid and trade on stock exchanges throughout the day, just like shares. However, smaller or niche ETFs may have wider bid-offer spreads, which can slightly affect trading prices when buying or selling.
8. Can I hold ETFs in an ISA or SIPP? Yes. ETFs are fully eligible for tax-efficient accounts such as ISAs and SIPPs. Platforms like InvestEngine allow you to invest in ETFs with as little as £1 through fractional investing, helping you diversify and make the most of your allowances.
9. Are ETFs suitable for beginner investors? ETFs are often recommended for new investors because they provide instant diversification, low costs, and transparency. They are a simple way to gain exposure to broad markets or specific themes without needing to pick individual shares.
10. How does InvestEngine make investing in ETFs safer or easier? InvestEngine offers regulated access to hundreds of ETFs, free from commission fees. Features such as AutoInvest, Savings Plans, and fractional investing help you stay diversified and invest regularly from as little as £1 — all within secure, FCA-regulated accounts.
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.
ETF costs apply. If in doubt, you may wish to consult a professional adviser for guidance.
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.