Ultimate Guide: How are Exchange Traded Funds different from Stocks?
We have seen how exchange-traded funds differ from mutual funds. Now let us focus on the difference between ETFs and stocks since both are tradeable on the ‘stock’ exchange.
In today’s day and age, investors have many choices to invest in to grow their wealth. Investing in stocks, bonds, mutual funds, ETFs, etc., the list is virtually endless.
The main aim of any investor is to see his investments grow; thus, each instrument brings many advantages and disadvantages.
Retail investors like you and I can choose from stocks and ETFs. Both are available on the stock market for trading. On the one hand, a stock offers ownership in a single firm; an ETF gives you a basket of securities depending upon the type of ETF you choose.
Thus, ETFs give you access to virtually any part of the financial market. ETFs are collections of stocks, bonds, commodity derivatives, and other investments traded on an exchange.
There are several differences between stocks and ETFs, but first, look at their similarities. Both the ETFs and stocks are taxable upon redemption. Both offer a steady income.
Stocks’ dividends are credited directly to the investors’ accounts after tax deductions. Similarly, the assets underlying the ETFs also generate dividends and returns, either invested back into the fund or given back to the investors after proper deductions.
You can choose both ETFs and stocks from various sectors. Similar to stocks, ETF trading can be done on the stock exchange.
What are the differences, then? ETFs are a group of securities packaged as a unit and listed on the exchange. These assets need not be only stocks but can be any security.
These ETFs are managed by professional fund managers who own the underlying securities. The investors concerned about the ETFs do not own the underlying assets directly and hence give no ownership and voting rights.
On the other hand, stocks listed on the exchange offer ownership and voting rights (if they are not preferencing shares) in a single company. Preference shares are the shares that give the investor a promised return at the cost of forgoing voting rights in the AGMs.
ETFs are managed by a professional, thus saving you the trouble of deciding which securities in the underlying assets of the ETF to sell or hold. In the case of stocks, investors need to be very vigilant in the market to know when to buy, sell, or hold.
Conversely, in the case of ETFs, investors don’t have any control over what happens to the portions of ETFs. Since ETFs have a diversified profile of assets, the risk associated with the investment reduces significantly.
Whereas in stocks, the risk attached is higher as the stock price depends entirely upon the company’s performance and other external factors (outside the control of the person in question).
The liquidity of a stock is way higher than the liquidity of an Exchange Traded Fund. However, in rare cases, the latter can have higher liquidity than the former.
The bottom line is that you should make every investment by studying the risks involved. The investor should keep his risk profile in mind before proceeding.
Most importantly, the strategies and goals of the investor are vital when choosing the securities. The right for one might not be the right choice for the other.
Keeping these fundamental differences and similarities in mind helps in better decision-making.