ETFs vs. Stocks: Which is a better option for investment?

If you’re unfamiliar with finance and investments, making an investment decision can be tricky. In this blog, we discuss two popular investment options—-ETFs and stocks—which should help you make an informed decision.

Understanding ETFs and stocks

If you want to invest in stock markets, you have two options, exchange-traded funds (ETF) and stocks. However, making the choice is confusing, especially if you are new to the investment world. Well, the answer depends on your risk levels and to what extent you want to be involved in the investment process.

Both ETFs and stocks come with their set of advantages and disadvantages. It is up to you to choose which one resonates more with you, considering your knowledge of financial markets and investing strategy.

Before you decide, let’s understand both in detail.

What is an ETF?

ETFs are just like stocks as they trade on stock exchanges. You can think of an ETF as a basket that comprises stocks, commodities, bonds, or other financial instruments. When you purchase an ETF, you buy a part of that entire basket.

There are different types of ETFs available, such as:

Index ETFs, which mimic an already established index like Nifty or Sensex.

Sector ETFs, which invest in a particular sector like auto or energy.

Inverse ETFs, which earn returns when the underlying asset’s price falls.

Commodity ETFs comprise commodities like gold, silver, and crude oil.

What is a stock?

When a company wants to raise funds, they go to the market and issue stocks (also known as shares). A stock represents a tiny part of the company. You own that portion by paying a certain price. Stocks are constantly bought and sold on stock exchanges. In India, we have the National Stock Exchange and the Bombay Stock Exchange, which list thousands of companies.

Depending on the company’s performance, the price of a stock goes up or down. Investing in stocks is a simple and popular method of investment. But it requires a deep understanding of the market and how various factors impact a company’s stock price.

Key differences between ETFs and stocks

Except for the fact that both ETFs and stocks are traded on an exchange, they are different forms of investment. Risk, liquidity, market sentiment, and costs make them different. Here is a table demonstrating the key differences between an ETF and a stock.

FactorsETFStock

Diversification

Allows diversification by combining several assets in a single ETF. This helps in lowering the risk of loss, even if one or more assets fall in value. Allows investment only in one company with one stock, hence diversification is not possible.

Trading and liquidity

Trading ETFs is simple as they can be bought and sold easily on an exchange during trading hours. Some ETFs may have less liquidity depending on their structure.Stocks are traded on a stock exchange, and the price of a stock depends on the bid and ask prices on that particular day. Some stocks have more liquidity than others.

Management and expense ratios

ETFs are managed by professional fund managers who charge management or expense fees for the same, but these fees are often low.There is no management or expense fee involved as you can personally handle everything.

Advantages and disadvantages of ETFs and stocks

Both ETFs and stocks have some advantages and disadvantages. It will be wise to weigh them before deciding which one will suit your investment needs.

Advantages of ETFs

  1. ETFs allow for diversification by combining assets of the same class and lowering the risk of failure if some assets lose their value.
  2. Professionals manage ETFs, which helps you save time and energy researching individual stocks.
  3. For stock trading, you can use all the available tools like market order, limit order, stop loss, shorting, set target, intraday trade, etc.

Disadvantages of ETFs

  1. You cannot control which assets can be part of an ETF.
  2. Some ETFs may attract high management fees.
  3. ETFs follow the underlying assets’ prices; sometimes, there could be a lag in the process.

Advantages of stocks

  1. Stocks can deliver much higher returns if the company performs well and market sentiment favors that stock.
  2. The cost of trading in stocks is minimal and sometimes even zero.
  3. Stocks are a good option if you have thorough knowledge about a company’s financial health and business model.

Disadvantages of stocks

  1. The price of a stock can fluctuate heavily in the short term, which can cause panic among new investors.
  2. You will need to spend much time researching a company and understanding various financial terms, which is time-consuming.
  3. Investing primarily in one or two stocks can lead to significant losses if those companies fail to perform.

Selecting the right investment option

Selecting the right investment option is crucial for creating wealth in the long term. Bad investments can scare people away from investing.

Factors to consider

There are some factors to consider before choosing between an ETF and a stock.

  • Time: If you have much time and patience to learn and study about a particular company or industry, choose stocks over ETFs.
  • Investment journey: If you are just starting out, then you might want to consider ETFs an option because they require less effort and knowledge to begin with.
  • Risk: Depending on risk appetite, stocks are suitable for risk-takers, whereas ETFs are preferable for risk-averse people.

Final thoughts on ETFs vs. stocks

Both ETFs and stocks are good investment options, and the choice between the two depends on the individual investor. ETFs require less effort and can diversify your portfolio, while stocks can deliver higher returns quickly. If you cannot decide, you can invest in both to obtain maximum benefits.

FAQs

Is ETF better than stocks?

The choice between ETFs and stocks depends on your investment goals. ETFs offer diversification, lower risk, and cost-effectiveness, while stocks provide potential for higher returns but come with higher risk.

Why is ETF not a good investment?

ETFs may not be suitable for all investors due to potential drawbacks, including fees, tracking errors, and sensitivity to market fluctuations. Diversification doesn’t eliminate all risks.

How is ETF different from stocks for beginners?

ETFs are like baskets of stocks, offering instant diversification, while stocks represent ownership in a single company. ETFs trade on exchanges, providing liquidity, while stocks offer direct company ownership.

Do ETF pay dividends?

Yes, some ETFs pay dividends. These are dividend ETFs that invest in a portfolio of dividend-paying stocks, providing investors with regular income.

Disclaimer: Risk is fundamental to the investment process in Indian stocks. Any discussion of securities in this article should not be considered a recommendation to buy or sell any security. The facts provided are for informational purposes only and should not be considered investment/financial advice from CoinSwitch.

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