Pros and cons of two different ways to trade
If you have been thinking about investing, you may have wondered should you invest in stocks or go for ETF trading. To understand the better option for you, you need first to understand what these two instruments mean.
When a publicly listed company wants to raise capital for its ventures, it issues shares, also called stocks, on stock exchanges such as the NYSE. When you buy stocks, depending on the number you purchase, you own a certain percentage of ownership in that company. The stock market has thousands of listed companies that you can choose from to invest in stocks.
Unlike stock, which is a single instrument, ETF(exchange-traded fund) is a combination of securities that includes diversified investments such as stocks, bonds, commodities, and other securities. Fund managers sell the shares to these holdings to investors, and investors interested in ETF trading may choose from many options available in the market.
ETF vs. stock: What to choose?
Both ETF and stock have certain similarities, like both of them provide an income source and both of them are taxable. There are hundreds of options available for both ETF and stocks, and both of them can be traded on the stock market throughout the trading day.
There are also some significant differences between the two, as listed below:
ETF offers lower risk
Since it is diversified, investing in ETF comes with lower risks. Investing in ETF means that you are investing in various entities, and it is highly unlikely that all of them lose their value at the same time.
Investing in stocks is like putting all your eggs in a single basket and is riskier. If the stock value falls, there is no other investment instrument to nullify the loss.
Need for a broker
If you opt for ETF, you will need a fund manager to manage the investment for you. On the other hand, it is not always necessary to engage a broker to invest in stocks. You can do thorough research and build up a robust portfolio for yourself.
Higher transaction fee
The transaction fee that you need to pay when investing in ETF is much higher as compared to stocks. However, the broker fees and expense ratio are usually lower for ETFs than stocks.
Since your ETF is managed by a fund manager, you are spared the trouble of deciding what portion of the ETF to sell or hold. Also, you do not have control over what happens to the portion of your ETFs. In the case of stocks, you have to be vigilant about the market to figure out the most opportune time to buy, sell, or hold. You also have more control over stock selection.
Investing in ETFs or stocks depends on your personal preference as well as your financial goals. Before deciding to invest in either instrument, identify your financial goals, and more importantly, your appetite for risk.
Regulation differences between ETF and stocks
Most ETFs are registered as investment companies with the SEC (US Securities and Exchange Commission) under the Investment Company Act of 1940. The shares that ETFs offer are registered under the Securities Act of 1933. Some ETFs that invest in currencies or commodities are not registered investment companies, although their publicly-offered shares are registered under the Securities Act.
The federal government regulates stocks and the stock market’s activity to safeguard investors and ensure the fair exchange of corporate ownership in the open market. The FINRA (Financial Industry Regulatory Authority) is the largest regulator of every broker or brokerage firm associated with the securities market in the U.S.
Advantages and disadvantages of ETF trading
The biggest advantage of ETF trading is diversification, as it provides exposure to a group of equities or market segments. Investors get the benefits of diversification, but ETFs have the trading liquidity of equity. Since it trades like a stock, it becomes possible to look up the daily price change.
ETFs are also passively-managed, and so they have a much lower expense ratio compared to other actively-managed funds. ETFs are also more tax-efficient compared to mutual funds and there is a minimal chance that ETF share prices are higher or lower than the real value.
The downside to ETFs is that they are subject to market fluctuation and the risks of their underlying investments. They are also subject to other expenses like management fees. Most ETFs also don’t re-balance their portfolios.
Advantages and disadvantages of stocks
The benefits of investing in stocks include higher liquidity, versatility, and higher returns in a shorter period of time. With technological advancement in almost every field, including the stock market, investing in stocks has become very convenient. Trades can be executed on an electronic platform ensuring that investors get the best investment opportunities in an open environment.
The biggest downside to investing in stocks is the amount of risk it carries. If the company performs badly, which can cause investors to sell, causing the stock prices to plummet. There is always the risk that you may lose your entire investment. Also, those who are operating on their own, need to do a lot of research when buying stocks. Each company needs to be researched to determine how profitable the stock may be.
Financial planners believe that you should plan your investments according to your financial goals, risk appetite, and the state of the economy in the business cycle.