Stocks are small fractions of a company issued to individuals or organizations as a way of raising funds. They are among the most traded assets in securities markets worldwide, and their price volatility is affected by the performance of the companies they are tethered to.
On the other hand, Exchange-Traded Funds (ETFs) are packages of different stocks and/or market indices. They are not issued by companies but are carefully selected by investment and brokerage firms and sold to buyers in securities markets. Funds track the performance of stocks or indices included in the ETF package.
Relationship between ETFs and stocks
This refers to the level of convenience or difficulty encountered when you want to convert an asset into cash or its equivalent. Stocks of large corporations are easier to sell than those of companies with weak financials.
Selling ETFs is more or less like selling stocks. All you need to do is place either a market order (sell at the prevailing market price) or a limit order (sell at a predetermined minimum price).
Market orders sell quicker because the brokers don’t have to wait for the “right” price. Since ETFs are carefully selected by experienced fund managers and traders, they are technically easier to sell unlike stocks chosen by individual investors, which may have been issued by junk-status companies.
Whether you have a stock or ETFs, you are liable to pay Internal Revenue Service (IRS) capital gains tax. The tax can be paid from dividends, the sale of your ETF, or stocks at a profit. Therefore, you should know your profit or loss margins to know how much is expected from you in taxes.
ETFs are by default diversified because they are a mixture of different stocks traded as a single unit. The only difference is that some ETFs are more diverse than others in terms of the number of stocks and the sectors tracked.
However, for one to diversify their stock portfolio, they have to buy shares from different companies listed in securities exchanges. Therefore you would spend more money to diversify with stock compared to having a similar number of stocks in a single ETF.
Level of research
As highlighted above, ETFs are put together by teams of seasoned professionals after having studied the performance of the individual stocks.
However, stock investors have to research and trade by themselves. This can be time-consuming, complex, and exhausting. The downside to ETFs is that you’ll have to pay an expense ratio, which is payment for the services offered. For stocks, investors do not incur expense ratios.
When are ETFs a good investment?
You should go for ETFs under the following circumstances:
- When you are not willing to take on big risks.
- If long-term investments are more appealing to you.
- When you want to diversify your investment portfolio.
The most appealing factor about the diversification in ETFs is the minimization of risks that comes with it. The probability of all the stocks included in an ETF to underperform is less as compared to the likelihood of a single company stock doing so.
The logic behind ETFs is that underperforming assets are covered by well-performing ones. In the end, you have some sort of insurance against losses.
The profit margins are generally limited in ETFs. With individual stocks, investors reap maximum benefits when the stock is performing well. However, it is unlikely for all the stocks in an ETF to perform well simultaneously.
When are stocks a good investment?
You should invest in stocks based on the following considerations:
- If your risk tolerance is high.
- You are keen on short-term profits.
- You want to outperform the market.
The risk levels of individual stocks are relatively higher compared to ETFs. With stocks, it is a typical case of putting one’s eggs in one basket. You stand to make a good profit when the company is performing well but could lose substantially if the company performs poorly.
The risks in stocks are such that you could still make losses if the company is performing well, but unfavorable market dynamics trigger investor panic. Trade tariffs and changes of political power in some jurisdictions may adversely affect the performance of a stock.
Summation of investing in stocks
Stocks are generally quite easy to invest in. Technological advancements have made it easier for investors to initiate trade without going through stacks of paperwork. There are many investment applications and software that have simplified investment in stocks and other securities.
You can track the market from anywhere using mobile devices and put alerts on positions you are interested in. Investing in stocks is a high-risk venture with the potential for making large profits.
With all the automation around stock trading, you still need a significant level of skills in research and understanding of the market to succeed. The alternative would be to hire the services of a qualified advisor to help you trade right.
Summation of investing in ETFs
ETFs offer investors a chance to diversify their portfolio without having to go through the rigors of researching several individual stocks. ETFs are easy to sell, just like most stocks. You can track the performance of your ETF holdings in real-time, thanks to breakthroughs in technology.
ETFs also have the advantage of attracting relatively low fees compared to actively managed funds such as mutual funds. However, they are a bag of mixed fortunes because some stocks often underperform while others do better. This leads to reduced profit margins. Funds’ other disadvantage is that they are subject to payment of expense ratios, unlike stocks.
ETFs and stocks can either work for or against you depending on your level of risk tolerance and whether or not you can bear with the shortcomings of each. Therefore, an investor should weigh the strengths and limitations of ETFs and stocks before deciding on which one to go for. Alternatively, you can try both and get the most out of them.