What is an ETF and how does it work? A complete guide to investing with exchange-traded funds

A first key distinction is accumulating vs distributing. An accumulating ETF automatically reinvests the dividends inside the fund, which favours compound interest and tends to be tax-convenient for long-term investors. A distributing ETF pays you the dividends in cash, useful if you are looking for periodic income. To build wealth over years, accumulation is usually the preferred option.

Another distinction is physical vs synthetic. A physical ETF actually buys the shares of the index (real replication); a synthetic ETF uses derivatives (swaps) to replicate the return without holding all the assets, which adds counterparty risk. For most investors, physical ETFs with full or sampled replication are the most transparent and recommendable option.

Finally, beware of leveraged ETFs (x2, x3) and inverse ones. They are designed to multiply the daily move of the index, not the long-term one, and because of the effect of daily compounding they can drift far from what you expect if you hold them for weeks or months. They are short-term trading tools, not vehicles for investing calmly over years.

The advantages of the ETF are powerful: instant diversification (hundreds or thousands of companies in one purchase), low costs (low TER), liquidity and a transparent price throughout the session, simplicity (you don't need to analyse each company) and the ease of automating contributions with DCA. For all that they have become the foundation of the portfolios of millions of retail investors.

But ETFs also have risks and limitations. The most important: they do not eliminate market risk; if the market falls, your ETF falls. Nor do they protect you from investing in a bad or overvalued index. And there are complex ETFs (leveraged, inverse, very fashionable thematic ones) that can hurt you a lot if you don't understand how they work.

There are also technical nuances: the tracking error (how much the ETF deviates from its index), the possible premium or discount to net asset value in illiquid ETFs, and currency risk if you invest in an ETF in a currency other than the euro. In large, physical, low-cost ETFs these problems are usually minor, but it pays to know them before buying.

Versus traditional index funds (not exchange-traded), the ETF trades on the market in real time and usually has very similar costs; the index fund, by contrast, has simpler mechanics for transfers in some countries and is bought at the closing net asset value. For the long term, both are excellent; the choice depends on fees, the tax rules of your country and operational convenience.

Versus individual stocks, the ETF gives you diversification and simplicity, but gives up the possibility of beating the market by choosing good companies at a good price. Buying individual shares offers more potential (and more risk) and requires analysis: knowing whether a company is quality and whether it is expensive or cheap. Many investors combine both: a core of ETFs and a portion in selected stocks.

There is no single answer. The practical rule: if you don't want to analyse companies, a broad, cheap index ETF is probably the best 'default' decision. If you are interested in analysis and want to try to add value with your own selection, that is where tools like DeepTicker make the difference.

DeepTicker does not analyse ETFs, but individual stocks, and precisely for that reason it fits well with a core and satellites strategy: the core of your portfolio can be a broad, low-TER index ETF, and the satellites, a selection of specific companies you choose with judgement. For that selection, DeepTicker shows you the quality of each company with the DeepScore (a 0-100 grade by sector, based on the analysis of quality and competitive advantage) and whether it is expensive or cheap today with the Reverse DCF.

With the screener of more than 140 filters and presets such as Graham or the Magic Formula, you can find quality companies at reasonable prices for your stock portion, while the ETF provides the base diversification. That way you combine the best of both worlds: simplicity and low cost in the core, judgement and potential in the satellites.

DeepTicker's spirit is to apply serious fundamental analysis but in a simple way, with every figure explained, so you learn by using it. None of this is financial advice; DeepTicker applies widely recognized fundamental analysis methods to public data, so you can decide for yourself with better judgement.