The term exchange-traded fund (ETF) is one of those bits of jargon that makes something seem more complex than it actually is. ETFs are an alternative to index- tracking funds, providing access to a wider range of countries and share indices. They can be bought and sold on an exchange in just the same way as equities.
The fees are low, too, because the funds simply follow the moves in an index and don't require the skills of a fund manager. According to the London Stock Exchange (LSE), annual charges on ETFs range between 0.2 and 0.75 per cent, while those on a unit trust can go up to 1.75 per cent. There is no stamp duty to pay when buying an ETF and they can be placed in an individual savings account, where growth is free of tax. The funds are bought through a stockbroker and the only upfront cost is the broker's fee – typically between £10 and £15.
There are hundreds of ETFs to choose from, including Barclays' iShares, Deutsche Börse's x-trackers and Invesco PowerShares. Their main appeal is that the number of indices they track is enormous and growing all the time. You can gain exposure to countries like China and Brazil, or other investments such as commodities. "If you aren't happy with your portfolio just containing equities and bonds and you want exposure to precious metals, you can buy a gold-bullion ETF," explains Christopher Traulsen at ratings agency Morningstar.
But there are dangers in investing in niche products. "You can easily shoot yourself in the foot. Providers do make some fairly esoteric areas of the market widely available," adds Mr Traulsen. "This can be good but also comes with some risk as people may end up putting money in areas that they don't understand."
It's vital to find out what the underlying investments of an ETF are and if those are set to continue to perform well. "You can buy anything from silver to wheat to soya beans. The danger is that providers can launch these products at a time when they think it's fashionable. You need to be careful you are not being sucked in and buying something at the top of the market," says Mark Dampier at independent financial adviser Hargreaves Lansdown.
He adds that ETFs should not replace shares and unit trusts in an investor's portfolio but be used to complement them.