Different types of securities are listed and traded actively on the Indian financial market. Among the many options available, stocks and ETFs are two of the most popular. As an investor, it is important for you to know what these financial instruments are and understand the differences between an ETF and a stock. This can help you decide which of these may be the right investment option for you.
To work out the finer aspects of the ETF vs. stock comparison, let’s begin by understanding what stocks and ETFs are.
What is a stock?
Also known as a share or equity, a stock is a financial instrument representing a unit of ownership in a company. The more shares or stocks of a company you own, the higher the percentage of your ownership is in the entity.
Companies may issue their shares to the public to raise capital via Initial Public Offerings (IPOs). The funds raised by selling a company’s shares are used to further its business objectives and manage its financial obligations. Once a company completes its IPO, its shares are listed on stock exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) and can be bought and sold freely among traders.
Types of stocks
Companies typically issue two different types of stocks: common stock and preferred stock. Here’s a quick overview of what they are.
Common stock
The primary category ofshares that companies typically issue is common stock. Also known as equity shares, these stocks confer ownership rights to the holder. Stockholders also receive other rights and privileges like the right to vote on certain business matters and the eligibility to receive a share in the company’s profits in the form of dividends.
Preferred stock
The issue of preferred stock, also known as preference shares, is relatively uncommon. Unlike common stock, preference stock neither offers any ownership right nor the right to vote. However, the holders of these shares are entitled to receive dividends at a fixed rate. Their right to dividends and payouts in case of liquidation are prioritised over the rights of equity shareholders.
What is an ETF?
Let’s take a closer look at what ETFs are before proceeding to the ETF vs. stock comparison.
ETF is an acronym for Exchange Traded Fund. It is a type of mutual fund where money from multiple investors is pooled together and invested in a basket of different securities. However, unlike traditional mutual funds, ETFs are listed on stock exchanges much like equity shares. The units of an ETF can be freely purchased and sold through the exchanges.
Types of ETF
Before listing the differences between ETFs and stocks, let’s go through the different types of Exchange Traded Funds you can currently invest in.
1. Regular ETF
A regular ETF is a mutual fund that invests in a basket of securities and is listed on the stock exchange for trading. The value of the units in these ETFs goes up when the prices of the securities in the ETF’s basket experience an uptrend. For instance, if there’s an ETF that tracks an index like the Nifty 50, the value of its units will increase if the index goes up and vice versa.
2. Inverse ETF
Inverse ETFs typically invest in derivative contracts such as futures and options. They are very similar to a regular Exchange-Traded Fund. The only difference is that their value goes down if the price of the securities or the index it tracks goes up and vice versa. For instance, if the benchmark index rises by 2%, the inverse ETF will fall by 2%.
3. Leveraged inverse ETF
A leveraged inverse ETF is an inverse Exchange Traded Fund that uses leverage to boost its returns. For instance, if the leverage in a leveraged inverse ETF is 2X and the index it tracks falls by 4%, the Exchange Traded Fund would rise by 8% and vice versa.
ETF vs. Stocks: Similarities
With the meaning and types of stocks and ETFs clarified, let us also look at a few similarities between the two. These include:
1. Transparency
Firstly, owning individual stocks is as transparent as it gets, as you make every investment decision yourself. Investing in ETFs is quite similar, as they are available daily with complete transparency. You can check what your investment is at any given moment. This helps investors stay aware when making strategic investment decisions.
2. Range and options of investment
Investing in stocks and ETFs offers a broad variety of investment options in different asset classes. This can cover different geographies, industries, and market caps.
3. Fees and commissions
Stocks and ETFs have transaction fees and commissions on trades as they are both listed on a stock exchange. However, some online brokers might also offer stock and ETF trading without charging any commission.
4. Trading and pricing
Another similarity is that individual stocks and ETFs can be freely traded on the stock exchange throughout the trading day. Both asset classes of stocks and ETFs are highly liquid as well. They enable investors to make swift decisions and modifications to their strategies to align better with the dynamic market conditions.
When it comes to the pricing of individual stocks and ETFs, both are directly aligned with the market prices as these securities are traded on exchanges. When it comes to ETFs, the prices of shares can vary a little from their net asset value (NAV).
Also, a broad range of trading techniques are applicable to both types of assets, including limit orders and margin trading.
5. Dividends
When you own individual stocks, you can directly receivedividends from the company. Similarly, in ETFs, you receive dividends based on the stocks you own in your portfolio.
What is the difference between stocks and ETFs?
Here’s a detailed table outlining the difference between an ETF and a stock.
Particulars | ETF | Stock |
| Meaning | ETFs are groups of securities which include bonds, stocks commodities, among others. | Stocks represent ownership in a company, giving investors a share in company assets and profits. |
Ownership | Investing in an ETF doesn’t provide ownership rights in the basket of stocks or index that it invests in. | Investing in a stock provides ownership rights to the company that issued the said stock. |
Voting rights | ETF holders don’t get any voting rights. | Equity shareholders get the right to vote on certain business matters during general meetings. |
Risk | The risk associated with an ETF is lower since it invests in a basket of different securities. | The risk associated with a stock is comparatively higher than that of an ETF. |
Management | Experienced fund managers professionally manage ETFs. | There’s no professional management involved with stock investments. |
Control | ETF holders don’t have any control over how investments are made or when to buy or sell investments. | Investors have maximum control over how investments are made and when to buy and sell stocks. |
Transaction fees | ETFs have slightly higher transaction fees compared to stocks due to expense ratios. | Stocks generally come with comparatively lower transaction fees. |
The pros and cons of stocks
Let us look at some pros and cons of investing in individual stocks compared to ETFs:
Pros
- Higher returns than ETFs: Stocks are generally riskier compared to ETFs. However, with higher risk comes the opportunity to reap higher profits, and the returns in stocks can be significantly higher than ETFs.
- Save on commission fee: Whentrading in individual stocks, you will come across options to trade commission-free and save on fees.
- Self-management: In addition to saving commission fees, portfolio management fees can be saved if you choose to manage the portfolio on your own.
Cons
- Higher risk: Individual stock investments can be riskier compared to ETFs, as each investment is dependent on a single company’s performance. Diverse portfolios under ETFs enable risk mitigation, as some indexed ETFs can even contain stocks spread among hundreds of companies.
- More effort: When you have to sit down and pick every stock you wish to invest in on your own, the process becomes extremely tedious and time-consuming. Consistently picking stocks you believe can fetch profits requires significant research as well.
The pros and cons of ETFs
Now that we have analysed the pros and cons of stocks, let us also take a look at the pros and cons of ETFs:
Pros
- Diversity: ETFs grant you access to the stocks of numerous companies that operate in different sectors and geographies.
- Less risk: The diversity of your portfolio spread across asset classes significantly reduces your risk, as the entire investment would never be affected all at once.
- Similar convenience: ETFs can be bought with the same ease as individual stocks from a brokerage account.
Cons
- Reduced control over actual investment: ETFs are essentially pre-selected funds, and you have no control over the specifics of which bonds or stocks your funds will be invested in.
- Underperforming returns: While they might be safer, ETFs generally have a lower rate of return. In many situations, returns from an over-performing ETF may still be lower than a single outperforming stock in your portfolio.
- Management fee: All ETFs typically have management fees higher than individual stock investments and reduce your cumulative profits. Even among the different types of ETFs, actively traded ETFs have a higher range of management fees.
Conclusion
With this, you must now know what ETF vs. stock is and how they compare against each other. One of the advantages of ETFs is that they’re inherently diversified since they invest in a wide range of securities. That said, although stocks are more focused, they have the potential to offer significant returns over the long run. Therefore, make sure to consider your risk profile and your financial objectives before you invest in a stock or an ETF.
Additional topics that you might want to read
- Open Interest vs Volume
- Bullish vs Bearish
- Difference between Day Trading and Swing Trading
- Shares vs. Stocks
- Difference between NSDL and CDSL
