ETFs and stocks have very similar attributes. Unlike mutual funds or other financial instruments, ETFs and stocks can easily be liquidated and traded. However, there are a few key differences when it comes to ETFs and Stocks. Pay close attention, because we’re about to look at ETF vs. stock and explain all the key differences.
ETF vs. Stock: Definitions
What is an ETF?
ETF stands for exchange-traded fund (ETF). Depending on the fund’s strategy, each holds a variety of underlying assets, such as stocks, bonds, options, or other investments. When you buy a share of an ETF, you’re essentially buying a small piece of each of the fund’s assets.
Although ETFs and mutual funds are both funds, there are a few key differences. Unlike ETFs, Mutual funds don’t trade freely during the day. Mutual fund trades are settled at the end of the session, so it’s a lot harder to capitalize on short-term price movements. Some mutual funds also require minimum investments and restrict sales, so they are much more cumbersome financial vehicles than ETFs.
Conversely, stocks and ETFs trade actively throughout the day. To offload ETF shares, traders simply put in a sell order while the market is open. Buying shares is a similar process. There are no minimum investments with ETFs either. If you have enough to buy a share, you can invest.
Ultimately, ETFs are much more flexible than mutual funds. In fact, most traders view mutual funds as antiquated financial tools. While they still serve some useful purposes, they have largely been overtaken in popularity by ETFs.
What is a Stock?
Stock is also called equity, and each stock is broken down into individual units called shares. Each share represents an ownership stake in the underlying company. Investors holding company stock effectively own a tiny portion of a company, and they’re afforded certain rights as shareholders. Some shareholders are entitled to dividend distributions, others have voting rights when it comes to major company decisions. It all depends on the company and the type of stock but, ultimately, each share of stock represents an ownership interest.
Like ETFs, stocks trade on various exchanges. NYSE and NASDAQ are the most reputable, but there are also smaller exchanges and over-the-counter markets.
Usually, companies issues stock to raise capital. Basically, the company sells pieces of itself in return for cash, which it can use to finance whatever operations it has in mind. This is called equity funding and, depending on the situation, it can be a preferable alternative to raising capital by borrowing. However, when equity funding is used in excess, it can dilute shareholder value and be negative for investors.
ETF vs. Stock: Differences
Here are the significant differences between ETFs and stocks
- In general, ETFs have lower risks because they are diversified holdings. With stocks, investors have all their risk concentrated in one company.
- ETFs are professionally managed. Stock investment requires a lot of research, and it takes time to build a strong portfolio.
- Traders have more control over stock selection when trading stocks. However, there is less need to pick and choose with ETFs
- ETFs are less volatile because they’re diversified.
ETF vs. Stock: Similarities
Although they are different asset classes, ETFs and stocks have some things in common.
- Both ETFs and stocks are traded actively throughout the trading day.
- They are accessible via traditional brokerage accounts
- Traders can invest in ETFs and stocks using margin.
- Both can be short sold.
Pros and Cons of ETF and Stocks
For ETF vs. stock, here are the pros and cons of trading each of them.
Pros of Trading ETFs
- A single ETF gives an investor exposure to a group of stocks. This diversification reduces the risk of failure on investments.
- ETF often have lower expense ratios than mutual funds.
- No minimum investments.
- Traders can reinvest ETF dividends immediately.
- Most larger ETFs are highly liquid.
- ETFs can be used to buy a variety of assets, including futures, options, bonds, and other specialized investments.
Cons of Trading ETFs
- ETFs have management fees.
- ETF dividends often yield smaller returns than certain individual stocks.
Pros of Trading Stocks
- No management fees.
- Dividend yields can be much higher.
- Most blue-chip stocks are highly liquid.
Cons of Trading Stocks
- Picking individual stocks requires significant research.
- You could lose a significant portion of your investment if your stock underperforms.
- Stock prices tend to be more volatile.
- Investments are concentrated in one company so there is less inherent diversification.
ETF Vs. Stock: Closing Thoughts
There are a lot of differences between ETF vs. stock, but they’re currently the most popular investment options on the market. They offer excellent liquidity and low barrier to entry, so they’re ideal for beginning investors.
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