What are the Differences Between ETFs and Stocks?

The primary difference between ETFs and stocks is that investing in stocks means taking partial ownership of a single firm, whereas investing in an Exchange-Traded Fund (ETF) distributes your risk across several companies.

However, being unaware that ETFs can provide market exposure with less risk, many beginners opt for stocks instead. As a result, over the following four years, JPMorgan predicts 17% annual growth for Indian equities.

This blog analyses the differences between ETFs vs stocks while explaining their advantages and disadvantages.

What are Stocks?

A stock is a financial instrument that represents a unit of ownership in a firm. Your proportion of ownership in a corporation increases with the number of shares or stocks you hold. Initial Public Offerings (IPOs) are a way for companies to raise money by issuing their shares to the general public.

A firm uses the money it raises from the sale of its shares to manage its financial commitments and meet its business goals. Following an IPO, a company’s shares are listed on stock exchanges such as the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), where traders are free to buy and sell them.

Now, let us analyse what ETFs are, since it is important to explore both the options before understanding the differences between ETFs and stocks.

What are Exchange Traded Funds (ETFs)?

ETFs are a financial tool which aggregates investor capital and allocates it to a variety of assets, including stocks, bonds, commodities, and indices. Investors can trade an ETF on the stock exchange like stocks, while being comparable to a mutual fund.

ETFs typically replicate the returns of a benchmark asset or index. To replicate the returns as accurately as possible, fund managers of ETFs invest in the same percentage of the underlying asset.

What are the Differences Between ETFs and Stocks?

The key differences between ETFs and shares rely on parameters such as ownership, performance, and other factors. The following table compares ETFs and stocks based on these parameters:

Different Types of Stocks

Along with the knowledge of ETFs vs stocks, you must know about the different types of stocks. These are:

• Common Stock

Common stock is the main type of shares that companies usually issue. These stocks grant the bearer ownership rights. In addition, stockholders are entitled to a portion of the company’s earnings in the form of dividends, as well as the ability to vote on certain business issues.

• Preferred Stock

Preferred stock is a group of shares that are not frequently issued. Preference stocks do not grant any ownership or voting rights, in contrast to common stock. Nonetheless, dividends at a certain rate are due to the owners of these shares. The interests of equity owners are subordinated to their entitlement to dividends and payments in a liquidation.

Different Types of ETFs

• Regular ETFs

A regular ETF is a mutual fund that is traded on the stock exchange and makes investments in different asset classes. When the prices of the stocks in the ETFs increase, the value of the units in these ETFs increases as well. An ETF that tracks an index will see a gain in the value of its units if the index rises, and vice versa.

• Inverse ETFs

Inverse ETFs make investments in derivative instruments like options and futures. They resemble a standard ETF quite a bit. The main distinction is that if the price of the assets or the index it monitors increases, their value decreases, and vice versa. For example, the inverse ETF will decrease by 1% if the benchmark index increases by 1%.

• Leveraged Inverse ETFs

An inverse ETF that employs leverage to increase its returns is known as a leveraged inverse ETF. For example, if a leveraged inverse ETF has a 2x leverage and the index it monitors declines by 3%, the ETF would increase by 6%, and vice versa. 

Advantages and Disadvantages of Investing in Stocks

Now that you understand the ETF vs stock difference, knowing the advantages and disadvantages of stocks is also important. Here are the advantages of investing in stocks:

• Higher Returns

In earlier times, stocks have demonstrated significant returns over a long period of time. This shows how stock investing may lead to passive wealth creation. However, it is important to emphasise how important it is to do a thorough study and analysis before making any investment decisions.

• Diversification

By enabling you to invest in a variety of businesses and industries, stocks provide the advantage of diversification. The impact of a single company’s poor performance might be reduced with a diverse stock portfolio. Gains from several stocks can counteract losses if one underperforms, improving stability.

• Dividends

You may be eligible to earn dividends if you own shares in a company. Since these dividends increase your overall investment returns while providing more income each year, stocks are a lucrative way to build wealth.

•  Ownership Rights

Purchasing stocks gives you a stake in the corresponding businesses. Voting rights on significant business issues that affect the company’s future are part of this ownership.

Below are some disadvantages of investing in stocks:

• Lack of Accurate Information

Collecting accurate and reliable information about certain companies may be a challenging task. Investors are more likely to experience financial losses if they make poor investing decisions due to inadequate or inaccurate information.

• Market Volatility

Due to high volatility, the value of your investment may fluctuate significantly even if you invest for the long term. Uncertainty and worry may result from these price fluctuations, particularly if you need to access your investments amid volatile market circumstances.

• Higher Expenses

Investing in multiple companies may result in higher expenses, such as transaction and brokerage fees.

• Asset Liquidity

Stocks may be easily purchased and sold since they are often very liquid. However, worries about liquidity may surface during market downturns. Finding prospective buyers for your stocks might be difficult under these circumstances, which could make it more difficult for you to sell your investments quickly.

Advantages and Disadvantages of Investing in ETFs

To have a better understanding of the difference between a stock and ETF, you must have a look at the pros and cons of investing in ETFs. Here are the advantages of investing in ETFs:

• Diversification

By investing in a diverse basket of assets, ETFs provide more diversification and exposure.

• Lower Expenses

ETFs have far lower expense ratios than actively managed mutual funds since they are passively managed. This entails lower management fees, accounting costs for shareholders, and other service prices.

• Low Tracking Error

The tracking error is the difference between the ETFs’ returns and those of the underlying index, such as the NIFTY 50. For instance, let us say the NIFTY 50’s daily return was 0.4%. As a result, the NIFTY 50 ETF’s return should fall within the same range. For an ETF, a tracking inaccuracy of up to 2% is allowed.

• Liquidity

ETFs offer flexibility since they may be traded all day long, particularly during periods of significant market volatility.

Below are the disadvantages of investing in ETFs:

• Limited Disversification

Due to the quantity of securities in the underlying index, certain ETFs may have limited exposure and therefore lose out on small-cap company development prospects.

• Lower Dividend Yields

Although there are ETFs that pay dividends, their yields might not be as high as those of individual high-yielding equities.

• Intraday Pricing Volatility

On exchanges, ETFs are traded in real time. Over time, this results in volatile returns. This can hamper low-risk investors’ investment plans. Before investing in any ETF, it is strongly recommended to assess your risk tolerance.

• Management Fee

All ETFs can lower your cumulative earnings and have management costs that are larger than those of individual stock purchases. Actively traded ETFs have a wider variety of management costs than other types of ETFs.

Stocks vs ETFs: Which is Right for You?

Based on the above differences between ETFs vs stocks, it depends on you which one you should choose among these two options. If you want the freedom to actively create and manage your portfolio, choosing individual stocks is the best option for you. 

On the other hand, ETFs may be the best option for you if you have little time to regularly watch the stock market. ETFs are professionally managed portfolios that make it easier for you to create an investment portfolio by allowing them to diversify their holdings across several ETF categories.

However, if you want to invest in both ETFs and stocks, you can download the PL Capital Group – Prabhudas Lilladher application and open a Demat account for free. PL allows you to choose the best stocks and ETFs according to your needs and risk tolerance.

When Should You Choose ETFs Over Stocks?

You can choose ETFs over stocks when you want to invest less or do not have enough financial backup. As per the comparison of ETFs vs stocks, you can choose ETFs over stocks in these circumstances:

1. If you are a beginner, it is more handy and does not require a lot of market knowledge.
2. If you like a passive strategy and wish to bet on a wider range of businesses, an index, or a commodity
3. You are looking to create a diversified portfolio and obtain exposure to several businesses or industries

Final Thought

Based on the key differences of ETF vs stocks, you can choose the better option according to your risk tolerance and investment goals. Seek expert advice from a broker or advisor to assist you in selecting the appropriate financial solutions to safeguard your future.

The PL Capital application also allows you to invest in a variety of securities like ETFs and stocks. PL Capital also provides expert analysis with data-driven research.

Frequently Asked Questions

• Are ETFs safer in comparison to stocks?

The differences between ETFs vs stocks show that ETFs are comparatively safer than stocks, since they offer more diversification and spread risks across numerous investments.

• Which one should you choose between ETFs and individual stocks?

Both individual stocks and ETFs have advantages and disadvantages. Choosing the right security depends on your investment objectives and risk tolerance.

• Which is the more cost-effective option between stocks and ETFs?

The main distinction between ETFs and stocks is the cost of investment. ETFs are more affordable than other choices like mutual funds since they often have lower expense ratios. However, stocks have lower transaction fees when trading expenses are taken into account. Brokerage commissions on ETFs might potentially reduce your gains.

• Which one offers a better diversification between stocks and ETFs?

In contrast to individual stocks, ETFs often provide more diversification. ETFs offer exposure to a variety of businesses or assets by investing in a basket of securities.