ETFs and stocks are two popular investment options for investors who are just getting started. They’re similar, but also quite different.
In this article, we look at the differences between these two investments, the pros and cons of each, and how each can play a part in your overall investment strategy.
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What are ETFs?
An ETF, or an Exchange Traded Fund, is a type of security. Much like a regular stock it’s bought and sold on the stock exchange.
Where they differ from regular stocks, though, is that an ETF is a package of investments; instead of one stock, you’re investing in a complete portfolio in one investment. This package can be made up of different types of investments that cover stocks, bonds, commodities, currencies, or a mixture of different asset classes.
The ETF you purchase tracks a specific commodity, sector, or index. So you might buy one that focuses on, say, iron ore, the mining industry, or on the ASX. They can also focus on either a single geographic region, or deliver a full global outlook.
The majority of ETFs are index-tracking, which means they mimic the movements and returns of a specific index, such as the ASX.
Sold as a package, ETFs are considered to be a marketable security, which means that they have an assigned price that allows them to be bought and sold, just like regular stocks. Their price fluctuates throughout the day with the market, and an ETF itself can be bought and sold at any point throughout the trading day.
With a low entry cost and low management fees, ETFs are a good option for those looking to try their hand at investing, but don’t feel they know enough to choose specific investments.
The pros and cons of ETFs
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[th]Pros[/th]
[th]Cons[/th]
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[td]Easy to get started using, as you only have to execute one transaction to buy and sell[/td]
[td]ETFs that are actively managed by a portfolio manager can have higher fees[/td]
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[td]Strong diversification delivers good risk management[/td]
[td]ETFs that focus on a single industry or commodity can limit diversification[/td]
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[td]Provide access to a wide range of investments[/td]
[td]You’re investing in a package of assets, giving you less immediate control over your investments[/td]
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[td]Offers the ability to focus on specific industries or indexes[/td]
[td]Can be slightly less liquid than regular stocks, due to their nature[/td]
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[td]ETFs with international investments can reflect foreign market prices before local markets do[/td]
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[td]Lower expense ratios[/td]
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[td]Less chance of broker commissions[/td]
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How are stocks different to ETFs?
Conversely to ETFs, where you’re investing in an entire portfolio, when you invest in stocks you’re buying individual investments. Also known as equities, a stock is a single share of ownership in a specific company. You’re investing in the company itself, and in return receive a share of their profits. The return your receive is equal to your portion of stocks your own.
When purchasing a stock, this technically entitles you to a portion of voting ownership in the company (whether you choose to exercise that right or not is another story).
Stocks are traded primarily on stock exchanges, such as the ASX. Their value changes as the company’s financial performance changes, and can be impacted by the industry, the economy, and various other factors.
The pros and cons of stocks
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[thead]
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[th]Pros[/th]
[th]Cons[/th]
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[tbody]
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[td]Easy to get started[/td]
[td]Can be high risk, as stocks are dependent on the company’s success[/td]
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[td]Easy to buy[/td]
[td]When you sell a stock you lose your initial investment[/td]
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[td]Engaging a stockbroker makes it an easy investment to manage[/td]
[td]Requires a lot of time to do research and due diligence when investing in stocks[/td]
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[td]With individual stocks, you have improved control over your investments[/td]
[td]Due to their volatility, it can be emotionally tiring to watch stock prices rise and fall[/td]
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[td]Stocks grow with the economy[/td]
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[td]Stocks are historically known to stay ahead of inflation, which means over time you get a better return[/td]
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[td]Easy to sell, and you can sell them at any time[/td]
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So, which is the best option?
The key thing to remember is that not all stocks are good investments. Not all ETFs are good investments. So what’s considered a good investment depends on your situation and what you are trying to achieve with your portfolio. This is why consulting a financial adviser is critical when starting your investment journey.
A well-selected portfolio of stocks can last 20 to 30 years — or even a lifetime. The benefit of holding individual stocks is having greater control and influence over your investments.
With individual stocks, you only need one big win to have a real impact on your life.
Let's look at an example. In 1994 health tech firm CSL was taken public and listed on the ASX for $2.30 per share. Fast forward to 2020 and the share price was $300. That’s a return of 130 times your money. And that doesn't include the dividends paid along the way. A $10,000 investment in CSL in 1994 would have grown to $1.3m over this time period.
But ETFs are also a great investment option. By buying an ETF, you can gain access to the share index of an entire sector or country. So they can be very useful when you’re looking to get exposure to countries or sectors you don't know much about.
For example, if you buy an ETF that covers the NASDAQ index in the USA, this potentially gives you access to fast-growth tech companies like Google, Amazon, and Apple. Or you can buy an Asian Index ETF that gives your portfolio exposure to the listed companies throughout Asia.
So when it comes to the question of which is best, both have their merits. We believe a well-balanced portfolio can hold both ETFs and individual stock.
The final word
Choosing which is the best investment option depends on what you’re looking to achieve
Investing in stocks yourself typically requires some understanding of the market and the companies in which you’re investing. They can be volatile, so are best left as a long-term investment. Often, stocks can take a lot of hands-on activity to ensure the best outcome. However you have more individual control, making them a more flexible option.
ETFs are a good option for those looking to invest in a diversified portfolio. They’re a more hands-off option, so good for new investors, and enable you to better manage risk, giving you more peace of mind. Ultimately, investing in ETFs doesn’t require as much intimate understanding of the market’s movement.
Both have their own value as part of a solid investment portfolio, so it all depends on what you want to achieve as part of your investment strategy.
