If you’re going to start investing in the stock market, the simplest way to do so is by buying and selling stocks and ETFs. Thanks to technology, investing in these financial instruments has become more accessible than ever. This article explains the differences between ETFs and stocks and how to think about them as part of your investment strategy.
What is a stock?
A stock is a portion of a company that is traded on a market known as an exchange. The New York Stock Exchange is a popular stock market. When people talk about the stock market in general terms, such as “the markets were strong today,” they’re usually talking about a portion of the market known as an index.
Two popular indexes are the S&P 500 and the Dow Jones Industrial Average. While both of these have their own methodologies for selecting and tracking representative companies, they are widely trusted as indicators of the overall trend of the market.
What is an ETF?
An exchange-traded fund, or ETF, is an investment fund that can be bought and sold on the stock market just like an individual company’s stocks. ETFs are a way to build a diverse portfolio in a single transaction because they can contain commodities, stocks, bonds, or track an entire sector of the stock market, such as the S&P 500. ETFs are easy to trade because they can be traded using online brokerages, and you don’t need a full-service broker or to interact with a particular company to make your transaction.
ETFs are made more accessible through the introduction of fractional investing. Investing apps like Public, for example, make it possible to buy into diversified ETFs at a lower price-point than would be needed to buy a full share.
ETFs vs. stocks: Similarities
Both ETFs and stocks are traded on stock exchanges, which means they are both widely available. Another similarity is that they are bought and sold at the price they appear to be at the time of purchase. That means, while the stock market is open, you can invest in an ETF or stock with ease and speed and know exactly what you’re getting and for how much.
ETFs vs. stocks: Differences
Stocks represent shares within individual companies, whereas ETFs offer shares of multiple companies within a packaged bundle. ETFs aren’t bound to a single company, so they can contain stocks in a particular sector or contain stocks that approximate a particular index, like the S&P 500, which contains stocks in multiple sectors.
The number of shares per stock tends to be relatively stable. Stock buybacks, splits, and secondary offerings may change the number of shares per stock, but these don’t happen with the same regularity as they do with an ETF.
The number of shares per ETF change so that the share price matches the Net Asset Value (NAV) as closely as possible. The NAV measures the aggregate value of stocks and shares within an ETF as compared to the index that the ETF is intended to approximate.
Stocks and ETF are easily transacted through exchanges and are widely accessible via online brokerages. Increasingly, these platforms have lowered their commission fees to zero, reducing the barrier to entry for retail investors who are looking to build a portfolio of stocks and ETFs. Public, for example, makes it possible to buy stocks and ETFs in slices, commission-free.
Liquidity factors of stocks vs. ETFs
Stocks and ETFs have nearly the same level of liquidity, meaning the ease with which they can be converted into cash. The ease of liquidity can vary based on the quality of ETF and stocks being traded. In general, high-quality stocks and ETFs have higher liquidity, whereas penny stocks and the ETF equivalent could take longer to convert.
Risk vs. reward
It depends. Stocks and ETFs are equally risky in that their relative risk depends on which stock and ETF you are investing in. An ETF that mimics a volatile sector like oil and gas can be just as risky as a high-volatility stock.
Tax implications of stocks and ETFs
Personal investors must pay taxes on any dividends and/or capital gains accrued from stocks and ETFs. Dividends are a portion of a company’s profits that are doled out to investors, whereas capital gains represent the income you make when an investment rises in value.
In certain cases, investors can deduct a portion of their losses from their tax obligation, which may offset some of the taxes paid on capital gains, but they can’t deduct fees paid to trade.
Income stream differences
Both stocks and ETFs can be steady streams of income, although by different means. There are stocks you can invest in that pay out dividends regularly. And there are ETFs you can invest in that contain bonds, loans made to governments or corporations, that are paid back on a regular basis.
When to choose stocks
Stocks tend to favor investors who are willing to put in the research needed to understand individual stocks and the factors that may influence performance in one way or another. If you’re passionate about a specific company and want to put in the legwork, you might find stock investments to be a good fit for you. You might also like the idea of placing bets on specific companies and leaders you believe in and tracking their journeys over time.
When to choose ETFs
Investors who want to invest in a broad sector, or are less interested in specifics at the company level, will favor ETFs. If the specifics are difficult or time-consuming to ascertain, ETFs allow you to invest in companies that tend to do well at the same time. Utilities, for example, all do well at once. Biotechnology, meanwhile, may be a lucrative investment but picking a particular company may simply require too much research, in which case an ETF is a good bet because it’ll let you profit from a swathe of companies. Additionally, investing in a sector rather than a particular company could make you less susceptible to unforeseen events at a company that could hurt its performance (e.g. a scandal or departure of a top executive) while the rest of the sector shines.
ETFs and stocks offer accessible entry points into the market and are easily traded within most investing platforms. Many investors prefer to build a mix of both in their portfolios since they each have their advantages. At the end of the day, it’s about understanding their similarities and differences and understanding how one or both can fit within your personal investment strategy.