Stock vs. ETFs: What's the Right Investment?
A question that is quite common amongst investors is what to choose between stocks and ETFs.
While deciding between stocks and ETFs, experts recommend picking the one that offers more exposure to the industry, helps widen profit margin by beating the market and reduces risks. This might sound daunting at first but once you have understood the pros and cons of both investments, you can make a profiting choice.
Before proceeding, remember that stocks are shares of a company listed on the stock exchange for raising funds, whereas ETFs, or exchange-traded funds, are a basket of various securities, such as stocks, bonds, commodities, etc., collectively known as holdings.
What is Stock?
Let’s begin by understanding what stock is. Simply put, private companies willing to raise funds list shares of their company on the stock exchange for investors to put their money in. These are called stocks of the company.
Depending on the number of stocks an investor owns, they get shared ownership in the company. These investors are called shareholders. There are thousands of companies listed on the stock exchange where you can invest your money.
Remember that stock is one instrument and while you can purchase multiple stocks, each stock represents a single share in the company, unlike funds.
Types of stocks
Investing in the stocks of a company gives you shared ownership of the company. However, the type of stock you own plays a vital role in the ownership benefits you get to enjoy.
There are two types of stocks, each having different features. Take a look:
As the name suggests, common stocks are general stocks of the company that provide you the legal right to elect a board of directors. However, in case the company is winding up, common stockholders are not on the priority list for paying back the money. Once the company clears repayment of creditors and preferred stockholders then common stockholders are repaid.
Going by the name it is obvious that preferred stockholders are given priority when the company is paying dividends. Preferred stockholders get regular dividends which are decided beforehand. However, they don’t have any voting rights in the company like common stockholders.
Pros and Cons of Investing in Stocks
Just like any investment you make, stock investments also come with pros and cons that you must factor in to make an informed decision.
Pros of Investing in Stocks
Stocks are considered a reliable and promising investment to generate income. The possibility of impressive returns with stocks has a positive track record.
As discussed above, stockholders are paid dividends by the company. Even if you are a common stockholder, the company will pay dividends when it makes a profit.
Investing in stocks is simple thus allowing you to invest in stocks of multiple industries and sectors. By creating a diverse stock portfolio you can mitigate risks better.
Cons of Investing in Stocks
Market volatility is a part and partial of investments you make in stocks. Regardless of your short-term or long-term goals, price swings can create panic.
In most cases, stocks offer liquidity. However, under unfavourable market conditions finding buyers can be difficult thus restricting your chances of selling investments.
The stock market is a wide space that makes it challenging to research, and stay updated with market trends and sentiments. In the absence of due diligence, you might end up making negative decisions that impact your investment portfolio.
What is ETF?
Exchange-traded funds, or ETFs, are a basket of securities, such as stocks, bonds, commodities, etc., collectively known as holdings. Unlike stocks, which are individual instruments, ETFs are a basket of instruments. However, they are sold and bought as individual instruments only.
When you purchase an ETF, there is no transfer of ownership; rather, you will be investing in the share of the fund that owns shares of the underlying company. What makes ETFs appealing for many is that they can be structured in any way that expands profit. ETFs can be structured to mimic price ranges or track large and diverse securities. This makes planning specific strategies simpler for investors and makes ETFs an interesting investment.
Pros and Cons of Investing in ETFs
Investing in ETFs can be profitable when made with due diligence. However, before you decide to put your money in, it is important to understand the pros and cons of ETFs:
Pros of Investing in ETFs
One of the most appealing aspects of investing in ETFs is its diverse nature. With one investment you can invest in multiple securities that help in portfolio diversification and ease losses by balancing it out with profit from a different security.
Most of the ETFs are passively managed which reduces the cost of management fees, accounting expenses etc.
Investing in funds like mutual funds has the limitation that their price is fixed once every day. However, ETFs are traded throughout the day, and their price changes provide trading flexibility and enhanced chances of making a profit.
Cons of Investing in ETFs
While providing trading flexibility, as a beginner you might find price volatility a challenge to deal with.
Since ETFs can be structured to track prices or large securities, there are high chances of making tracking errors.
Investing in an ETF is cost effective only under passively managed funds. Investors interested in actively managed ETFs have to pay much higher fees.
Investing in ETFs provides dividends through underlying stocks but the yields are not as high as stocks.
Other Types of ETF
Before you move ahead with the similarities and differences between ETFs and stocks, let’s take a quick look at inverse ETFs.
Now that you have reached here you must have understood that ETFs try to make a profit when the value of the fund increases and this happens when the underlying security is in a bullish position. However, there is another type of ETFknown as inverse ETF working on different principles.
Inverse ETF is a type of Exchange-traded fund that makes a profit from market declines. This type of ETF appoints derivatives and strategies to benefit inversely from the benchmark. In most cases, the focus is on derivatives such as futures and options. Simply put, if the target index falls by 1% in the market, inverse ETFs try to make a profit by gaining 1%.
This type of ETF is appealing to investors who want to continue making a profit even from market decline. However, it requires smart market strategies to pick the fund.
Similarities and Differences Between Stocks and ETFs
Stocks and ETFs have both similarities and differences that you would want to factor in to make the right choice.
Similarities between Stocks and ETFs
Traded in a similar manner
Both can be bought on margin and sold short
Stocks and ETFs are taxable
Both offer multiple options
Differences between Stocks and ETFs
Stocks are individual instruments representing a share ownership in the company whereas ETFs represent a basket of different securities.
Through stocks you need to select different individual stocks for diversification while investing in ETFs automatically creates a diverse portfolio.
Investing in stocks gives you access to a specific industry whereas ETFs provide access to multiple industries based on the fund objective.
Investment in stocks provides complete control over the stock. On the other hand, ETFs are passively managed i.e. fund managers decide the unit buying and selling.
Stocks and ETFs – Which is Better for You?
Deciding between stocks and ETFs should be based on your investment requirements and goals. For instance: If you want to actively manage your investment and have complete control then stocks sound like a better option. On the other hand, ETFs work well if you don’t want to monitor every market trend and sentiment since they are managed by a professional fund manager.
The Bottom Line
Just like any investment decision you make, selecting between stocks and ETFs requires you to perform due diligence and choose what best aligns with your investment goals. Remember that you can also take a blended approach as it will help you recognise and benefit from the unique advantages of both of them. To kick start the journey as an investor you can seek professional help or rely on data provided by a credible online trading account.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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