ETFs vs Stocks: What’s the Difference?

When it comes to investing, there are many different options. Two of the most popular choices are ETFs and stocks. But which is right for you?

To help you decide, we’ll explore the similarities and differences between ETFs and stocks, as well as their benefits and downsides. Let’s get started!

What Are ETFs?

Exchange-traded funds (ETFs) are investment funds that hold a collection of assets, such as stocks, bonds, and commodities. When you purchase an ETF, you don’t own any of the assets included in the fund. You only own a portion of the profits.

Essentially, ETFs combine some aspects of mutual funds and stocks. Like a mutual fund, an ETF is a pooled investment vehicle that offers exposure to a diversified portfolio. But unlike mutual funds and just like stocks, ETFs are traded on stock exchanges and can be bought and sold intraday at fluctuating prices.

An ETF may be actively or passively managed. Actively managed ETFs usually have higher fees due to the presence of an investment manager overseeing the performance of the stocks within the fund. Most, but not all ETFs, are passive, though.

What Are Stocks?

Stocks are shares of ownership in a company and can be bought and sold like any other security on the stock exchange. When you invest in stocks, you become a shareholder of that company. This means you have partial ownership of the company and are entitled to certain benefits, such as voting rights and dividends.

While there are many types of stocks, they can be classified into two main categories: common stocks and preferred stocks. Common stocks generally pay dividends on a regular basis (usually quarterly). Preferred stockholders don’t receive any dividends but are given priority when it comes to liquidation.

ETFs vs. Stocks: Similarities and Differences

Now that we know more about ETFs and stocks, let’s compare them.

Similarities

• Both ETFs and stocks can be bought and sold on the stock exchange.
• ETFs and stocks are traded at the price they appear to be at the time of order.

Differences

• Stocks are shares of ownership in a company, whereas ETFs don’t have an underlying asset that makes up their value. Instead, ETFs track the performance of an index (such as the S&P 500) or a basket of assets.
• With individual stocks, you choose how to build your portfolio. On the other hand, with ETFs, you invest in an existing collection of assets without participating in the selection process.

Benefits of Investing in ETFs vs Stocks

As mentioned above, ETFs are similar to mutual funds. But compared to them, they are generally less costly. But are they cheaper than stocks, too? Well, it depends on several factors, including your investment strategy and stockbroker. But with ETFs it is cheaper to get meaningful diversification than buying individual stocks.

Another benefit of investing in ETFs is that it’s less risky than investing in individual stocks. When you invest in an ETF, your money is spread out across several different companies and industries. This reduces the risk of losing money if one or two of those companies lose value.

Investing in ETFs also requires less research and specific knowledge. A professional does all the work for you, saving you a lot of time and effort.

Finally, investing in ETFs can be more tax-efficient. Because ETFs trade like stocks, they are subject to short-term capital gains taxes. However, because mutual funds sell their underlying holdings when they redeem shares, they can sometimes generate long-term capital gains, which are taxed at a lower rate.

Downsides of Investing in ETFs vs Stocks

There are a few key downsides to investing in ETFs vs stocks. First, ETFs are not as liquid. An exchange-traded fund will always trade less frequently than stocks because there are fewer shares outstanding, and each share costs more money.

As an ETF investor, you also don’t have much control over where your money goes. For some people, research and decision-making are the most thrilling aspects of investment. If you’re a stock investor, you choose which companies to invest in, when is the time to sell or increase your holding.

And finally, while losses from a poor-performing asset within an ETF can be offset by a better-performing one, the same applies to gains. This limits the investment’s earning potential.

Key Takeaways

The ETF market is still relatively new, so it’s hard to say what the future holds for ETFs vs. stocks, but they do have some advantages over traditional stock investing.

ETFs allow investors to diversify their portfolios, invest in a wide variety of companies and industries without paying so many fees or taking on too much risk. They also allow for less involvement in active trading and research.

Yet, for some investors, having control over their portfolios is essential. Also, many are lured by the potential of earning big by picking a “winner” stock.

All in all, you can solve the stocks vs. ETFs dilemma by evaluating your personal preferences and investment goals.