Stocks and ETFs are both investment tools.
They serve a similar purpose but operate in different dimensions. Therefore, understanding their difference will help you make better choices.
What is a Stock?
A Stock also known as Equity is a kind of investment that involves the buying and selling of a company’s units of ownership, otherwise known as shares.
When you buy a company’s shares, you are investing only but in one company. You own a part of it as a shareholder.
So if the company performs well and goes up in value, the investors/shareholders benefit from the capital gains, but if it goes down, they lose.
What is an ETF?
An ETF (Exchange-Traded Fund) is another type of investment, more like the combination of Stocks (how it is traded) and Mutual Funds (how it tracks its underlying assets).
Investors can buy and sell funds (holdings) on exchange. Funds comprise a group of assets such as bonds, shares, commodities and other securities.
An ETF investor trades in a broader range of markets to build a diversified range of portfolios. When you invest in ETF, you spread your money over hundreds of other investments.
So that, even if one of the company’s prices fall, the rest of the other investments will not be affected.
It may be challenging to know which kind of investment is better, especially for new investors.
That is why it is crucial to weigh the associated risks involved and know what you are going into.
Differences between Stocks and ETFs
ETFs, come with lesser risks. It engages in diversified portfolios of different establishments. Instead of putting all your eggs in one basket, you spread them across other 100 investments, for example.
With that, you get a fair share from those different investments. It encourages diversification.
In case a company losses value, you only have to lose the percentages you invested there. Also, it is uncommon for all companies you invested in to lose value.
When compared to other kinds of investment, Stocks seem to be more unstable. Even more, when you risk everything on one endeavour, you will gain immensely if there is a rise in market value but loss tremendously if there is a fall/crash.
Stock can be riskier unless you diversify your investment. The essence of diversification is primarily to reduce risk and not to maximize return.
Bottom line: ETFs come with risks as some ETFs can have similar risks as a single Stock.
However, on a general note, investors of ETFs tend to sleep better and worry less about the associated risks involved in losing.
2. Expense ratios
Stocks have no expense ratios. It is more like buying an individual Stock and having control over it.
On the other hand, funds like ETFs have expense ratios. However, it has lower expense ratios when compared with different kinds of funds.
For example, ETFs have a lower expense ratio even when compared to passively managed mutual funds.
The cost of ETFs expense ratio varies depending on the investing method. ETFs can be actively or passively managed.
Actively managed ETFs mean you employ the services of a broker/portfolio manager. You pay them for the management expenses, including advertising costs, administrative fees and other operating costs.
Passively managed ETFs attracts lower expense ratio, fewer or no broker’s commission. More importantly, the lower the expense ratio, the higher the return over time.
Bottom line: ETFs can incur higher fees or not depending on the investing method. Investing in individual stocks costs less than ETFs.
3. Investment control
Stocks have higher investment control over ETFs. It gives you 100% control and flexibility over your investments and Stock allocation.
You have a say in the management of the company you are investing in. Also, you independently supervise and monitor your assets and portfolios.
In as much as you are in control, the responsibility can be too much for some investors.
When it comes to ETFs, investing in them will make you give up some control.
There is a need to employ the services of a portfolio manager. He/she is responsible for selling shares of the holdings to investors and doing other management jobs for you.
It lessens the load of responsibility but incurs an additional cost, which can impact your expense ratios in the long run. More so, they make critical decisions for you.
Some ETFs can give the investor more control over the other.
Bottom line: Investing in Stocks makes you feel like a boss as you can delegate authority. However, with ETFs, the shared responsibility reduces your control.
4. Higher Return
Stocks are more profitable (rewards) than ETFs if the market value favours them. Conversely, it can lead to a more significant fall (risks) when the value declines.
For ETFs, the returns are minimal but also carry minimal risks. The ability to diversify ETFs dilutes the potential returns and risks.
That means for low-risk investors, ETFs may be an excellent option. Stocks can be a great investment tool for investors with a higher risk appetite to make many profits.
Bottom line: The higher the risks, the higher the return, and vice versa.
Similarities between Stocks and ETFs
1. They are both taxable
How to calculate capital gain: Total sale price – the original cost of the asset.
2. Can be sold short
A margin account helps you to borrow funds. Buy securities to sell. Make gain and repay. It increases your purchasing power when you do not have enough funds.
3. Tradable on the Stock exchange
Although ETFs may have some features of mutual funds, it is still traded just like Stock. That implies you can buy, sell or even hold your Stocks or ETFs shares as much as you want.
In addition, both encourage intra-day trading. That means you take the position of the Stock and closes it within the trading time frame the same day.
4. Dividend payout
Both ETFs and Stocks pay out a dividend. Companies share the profit made among their shareholders. The investors can either receive it as cash or re-invest it.
However, how the company decides to pay is entirely up to them. It can be monthly, quarterly or yearly.
Investments come with risks and unique benefits, regardless of the type. Thus, you have to weigh the risks and potential returns in any investment before adding them to your portfolio.
Thanks for reading, please let me know your thoughts and comments below.
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Sagar Sridhar is a personal finance blogger from Canada. His genuine passion for personal finance coupled with his unique style of writing is what stands out. Professionally, he is a computer engineer, agile certified and has a master’s degree in Project Management. His writing has been featured or quoted in the leading Canadian publications such as Credit Canada and many other personal finance publications. While he is juggling between his day job and blogging, he is the main author on this blog and has miles to go before making the final pit stop.