Stocks vs. ETFs: What Are The Differences?
Whether you’ve been investing for a while or you’re just starting to invest, you have several options to invest in.
Most people have heard of investing in stocks or bonds, which are commonly mentioned in TV shows and movies.
People who have done some research may also have heard of mutual funds or ETFs.
Several other options also exist, including real estate investing, index funds, alternative investments, cryptocurrency, and more.
If you’re trying to decide between investing in stocks and exchange-traded funds (ETFs), here’s what you should know to make an educated decision.
What Are Stocks?
Stocks are the representation of tiny pieces of ownership in a company.
When you own part of a company, you usually get a say in how the company is run and a share in the profits of the company.
The shares of stock you own may give you a right to vote on initiatives the company puts before its shareholders.
While this sounds impressive, it doesn’t end up working the way you’d think in practice.
Companies often have millions or billions of shares of stock. If you own a single share, your vote won’t make much of a difference in the company’s direction.
Instead, founders or large investors with considerable positions in the company have a heavy influence over the votes.
Companies aren’t required to share profits with their shareholders directly but some do.
Companies that make dividend payments are distributing excess earnings to their shareholders.
These distributions may be as small as a few cents per share. However, shareholders with several shares can result in larger distributions that make a difference.
Even if companies don’t issue dividends, the growth of the company and its profits may result in a higher stock price.
This is another way you can profit from a company’s growth and earnings once you sell your shares.
Benefits of Investing in Stocks
Investing in stocks can have advantages.
Pick Individual Investments
When you invest in individual stocks, you pick exactly which stocks you want to own.
This allows you to build a detailed strategy to meet your specific goals.
Some people prefer actively trading, where they buy and sell individual stocks.
Other investors may like buying individual stocks and holding them for the long-term before they sell shares.
No matter which option you choose, you’re in control.
You get to choose all of the following:
- Which stocks you buy
- When you buy
- How much you buy
- How long you hold
- When you sell
- How much you sell
These decisions will likely be influenced by the company’s performance and stock price.
No Expense Ratio Fees
ETFs and mutual funds charge expense ratios, which are annual fees you end up paying every year.
These reduce your returns over time.
If you instead held the stocks the ETF is made up of, you wouldn’t pay any fees unless your brokerage charged account maintenance or other relevant fees.
If an individual stock and an ETF each have the same 8% annual returns but an ETF has a 1% expense ratio, you’re at a huge disadvantage investing in the ETF due to the fees.
Drawbacks of Investing Using Stocks
Investing in stocks isn’t for everyone.
When you buy and sell individual stocks, you must research the companies you invest in.
Without proper research, you won’t have a basis for knowing when to buy and sell the individual stocks you’re targeting.
Each company issues financial statements detailing its performance. Reading these may require you to understand corporate finance terms.
Analysts also share information about stocks and how they expect them to perform.
Detailed stock performance data can also be viewed on charts. Some people perform technical analyses of these charts to help determine when to invest.
Reading through all of this data and understanding it takes a significant amount of time.
After performing the research, you may decide a stock isn’t a suitable investment.
Then, you have to start the process over again as you look for your next investment.
Time to Maintain
Just like you have to spend time searching for investments, you have to spend time to decide if they’re worth continuing to invest in.
You have to keep up to date on the stock’s price movements. You should pay attention to earnings calls, financial statement releases, and analysts’ insights.
As long as you own an individual stock, you must spend time to maintain your knowledge of it or you could end up missing the perfect time to sell.
Risk of Loss
Not all companies succeed. Some end up failing.
In these cases, the companies’ share prices can go to zero, resulting in a complete loss of your investment.
Not all companies will fail, though. Some may simply underperform the expectations. In these cases, you could lose some of your money.
Even so, investing in stocks or any investment can be risky.
Understand what you could potentially lose and make sure you’re comfortable with that before investing in individual stocks.
What Are Exchanged-Traded Funds?
Exchanged-traded funds are an investment made up of several other investments.
By purchasing a share of an ETF, you essentially own a piece of all of the investments within the ETF.
Investment managers professionally manage these funds so you don’t have to pick and choose the investments.
These can take several forms depending on what they invest in.
Some ETFs invest in bonds. Others may invest in individual stocks.
ETFs may track a particular industry or an index as a whole, such as the S&P 500 index.
Specialized ETFs may invest in currencies or commodities, too.
Because ETFs have to be managed, they incur costs. These costs are passed on to owners of the ETFs through an expense ratio.
This essentially amounts to an annual fee in the form of a percentage.
Pros of Investing in ETFs
ETFs offer many benefits.
One significant benefit of ETFs is the instant diversification they offer. Rather than buying a single stock, ETFs usually hold a handful of investments.
You do have to be careful, though. The diversification may not be as much as you think.
If you invest in an ETF focused on technology companies, all investments within the ETF will be focused on technology.
You generally won’t have a ton of exposure if one particular company within the ETF performs poorly.
Even so, the entire sector could underperform, resulting in lower returns or even a loss.
Thankfully, some ETFs focus on diversifying across a wide variety of investments, such as the S&P 500 index or the entire stock market.
Fees Typically Lower Than Mutual Funds
While ETFs have more fees than stocks, they generally have lower fees than mutual funds.
This allows you to keep more of your investment for yourself.
The impact really shows up when you hold your investment over decades and your higher returns have more time to compound.
May Require Less Time
Thanks to the diversified nature of ETFs, they usually don’t require as much time to maintain.
As long as you believe in the goal of the ETF and have a long-term time horizon, they shouldn’t take as much time to manage as individual stocks.
Cons of Investing Using ETFs
ETFs aren’t perfect for every situation.
Fees Usually Higher Than Stocks
You may have to pay commission when you trade stocks, but most brokerages offer commission-free trades.
ETFs typically require you to pay an expense ratio, although a handful of ETFs have a 0% expense ratio.
This expense ratio can be relatively small, such as 0.05%, or it can be high, such as 1.00%.
The lower the fee is, the more of the returns you get to keep. Either way, the fees will reduce your returns.
Can’t Pick and Choose Certain Investments Within an ETF
While you can buy an ETF that meets your investing goals, you can’t tell the ETF to buy or sell a particular position within it.
Let’s say you want to invest in a handful of banks and choose an ETF focused on banks.
Upon further analysis, you decide you don’t want to invest in Wells Fargo.
If the ETF invests in Wells Fargo, you would have to sell the ETF to liquidate your exposure to the company.
Then, you’d have to find a different ETF that meets the same goals but doesn’t invest in Wells Fargo or invest in individual stocks.
May Not Perform Exactly as Expected
An index fund ETF tries to match the index that it follows. However, index fund ETFs may not always track the returns exactly.
As the index changes, minor variations may occur between the ETF and the index.
Fees also must be taken out of the ETF’s returns to cover the expense ratio. This will result in lower returns than the index over time.
How to Incorporate Stocks and ETFs in Your Investing Strategy
Stocks and ETFs can both be part of your investing strategy.
The first thing you should do is identify your investing goals.
Then, look for investments that can help you meet those goals.
Whether those investments are stocks or ETFs, have a plan for how you plan to use your investments.
Know what would cause you to purchase or sell your positions.
When investing, make sure you own a diversified set of investments.
This way, one bad investment won’t likely sink your entire portfolio since the risk is spread across several investments.
You don’t have to choose between stocks vs. ETFs.
If it makes sense, you can own both within your investment portfolio.
Ultimately, it depends on your portfolio management strategy.
In some cases, you may want to look at products and services other than stocks and ETFs, too.
If you’re unsure about what specific investments you should choose or are having trouble making investment decisions, you may want to consult an expert.
A fee-only fiduciary financial advisor doesn’t accept commissions and will make suggestions based on your situation and best interests.
You do have to pay them for their time, though.