An ETF, which stands for "exchange traded fund", is a fund that is bought and sold on the stock exchange like a share. It groups together values, bonds or other assets in a single basket, and its usual objective is to replicate the behaviour of an index. Understanding what an ETF is proves useful for any saver wanting to invest in the market without choosing company by company, and the basic idea is simple: to buy a portion of many investments with a single transaction.
The operation has several components that are worth knowing. The manager buys the assets that make up the index in the proportion dictated by it, or resorts to derivative instruments when the replication is synthetic. The shares are traded on the stock exchange during the session at a price set by supply and demand at any given moment, and this price remains close to the net asset value thanks to the work of market makers, entities that commit to buying and selling the product continuously.
How it differs from a traditional investment fund
The main difference lies in how it is bought and sold. A traditional fund is subscribed and redeemed at a net asset value calculated once a day, usually at closing. An ETF trades throughout the session, so it can be bought mid-morning or late in the afternoon at the current price, just like a share. This liquidity facilitates quick entry or exit, although it also invites more frequent trading than necessary.
Another relevant difference is the cost. Most index ETFs have a low total expense ratio (TER), which in many cases is between 0.1% and 0.5% annually. This percentage has a significant impact on long-term profitability, as it is deducted every year, and actively managed funds tend to charge much more. The investor must also add the broker's commission for each order and the spread between the buying and selling price, which can be higher in funds with low trading volume.
The first ETF to hit the market appeared in the United States in the early 1990s, and since then the product has spread worldwide. In Europe, growth has been particularly rapid over the last decade, both in terms of the number of available funds and the number of individuals using them as a basic investment tool.
Most common types of ETFs
The offering is broad, but almost all products fit into a few families. Index ETFs replicate broad markets, such as the S&P 500 in the United States or the Euro Stoxx 50, and are the most common option among long-term investors. Sector ETFs focus on specific areas such as technology, energy or health, while thematic ETFs bet on a trend, for example, artificial intelligence or energy transition.
There are also fixed income ETFs, which track indices of public or private bonds; commodity ETFs, which replicate metals like gold or silver, or baskets of energy and agricultural products; and currency ETFs. On the riskier side are leveraged ETFs, which aim to double or triple the daily movement of the index, and inverse ETFs, which rise when the index falls. They are designed for very short timeframes. As they are rebalanced daily, their accumulated behaviour over weeks can deviate significantly from what the index does, something that is not always understood at first glance.
Within this family, volatility-linked ETFs stand out, which are constructed with futures on the VIX index. Their profitability is eroded by the cost of renewing those contracts, an effect known as roll, so they are not instruments intended to be held for months.
Risks to keep in mind
An ETF does not guarantee any results. If the index falls, the value of the share also falls, and the loss can be very high in concentrated or leveraged products. When the underlying asset is denominated in dollars, the exchange rate adds another source of variation, and in funds with low volume, liquidity risk can increase the cost of the operation by widening the spreads.
Synthetic ETFs, which replicate the index through financial swaps with a counterparty, also introduce the risk that this counterparty may default on its commitments. European regulations require guarantees to be provided in these cases and limit exposure, but it is advisable to check in the product sheet how each fund replicates. The key information document (KID) includes the risk profile, costs, and replication method, and is the first place to consult before purchasing.
Taxation for residents in Spain
For a Spanish investor, the gains obtained from selling an ETF are taxed as capital gains within the savings base, with progressive rates ranging from 19% to 28%. The dividends distributed by some ETFs are also included in this base. Another aspect to consider is the country where the fund is domiciled, as it influences the withholding tax applied to dividends. Many ETFs marketed in Europe are domiciled in Ireland. This information is general, and each taxpayer's situation depends on their case, so it is advisable to confirm it with a tax advisor.
How to start investing in an ETF
To buy an ETF, you need a securities account with an authorised broker. In Spain, the CNMV supervises the entities operating in the market and maintains public registers where you can check if a firm is authorised. Once the account is opened, the purchase is made like any share: locate the fund by its ISIN or ticker, indicate the amount and type of order. Before doing so, it is worth reading the KID, reviewing the TER, and deciding what weight the fund will have within the total portfolio.
Diversification does not consist of accumulating similar ETFs. Two funds that replicate the same index provide the same exposure, even if their costs are different. A simple approach is to use a broad ETF as the core and, if the investor wishes, add a thematic complement with a reduced weight. Those who contribute money periodically can also spread their purchases over time, which smooths out the effect of more volatile moments.
In the end, what says the most about an ETF is in its technical sheet: which index it replicates, by what method, how much it charges per year, and what risks it assumes. These four pieces of information explain a large part of what the fund can do for the investor, and what it cannot do.
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