ETFs Vs Stocks: Difference Between ETFs and Stock

In the world of investing, ETFs(Exchange Traded Funds) vs stocks is amongst the most discussed topics. Although both are traded directly on the stock exchanges, to make a fair comparison between the two investment options, an investor must understand the characteristics and distinguishing features like risk factors, diversification, no. of securities, etc.

In this blog, we will discuss these factors so that you can make an informed decision on stock market investments and ETF investments.

ETFs vs Stocks

Stocks represent part ownership of a company, and through the IPO process, a company sells its shares to investors. The extent of this ownership is dependent upon the number of shares you hold to the total number of shares of the company. As an investor, you can buy the shares of a company from a stock exchange and hold them in your Demat account.

On the other hand, equity ETFs are funds which invest in stocks, fixed-income securities, commodities and other securities. The individual securities that these funds hold are called as fund’s holdings. 

These ETFs are traded just like an ordinary share on a stock exchange, and so an investor can purchase these ETFs directly through an exchange through his broker’s trading account. 

Benefits of Stocks

Investing in stocks can be really good for investors. When you invest in stocks, you can earn money in a few different ways. Sometimes, the company pays you a part of their profits as a dividend. 

The company can also buy back its own stocks and this generally pushes the  price of its stocks up. Generally if you hold onto good quality stocks for a long time, their value usually goes up, which can make you a lot of money.

Benefits of ETFs

Investing in ETFs has its own advantages over holding stocks. Since ETFs consist of many components, they provide diversification to investors. 

The underlying securities decides the value of ETFs and hence large deviations in the price of ETFs are not generally seen when compared to the underlying securities. Also, just like stocks ETFs also provide returns in the form of dividends and capital appreciation.

What is the difference between ETFs and Stocks?

ETFs generally invest in a number of securities and are managed by professional money managers. Stocks on the other hand represent individual shares of a company and can be bought individually by any person to make an investment. 

Thus stock units cannot provide diversification benefit and risk reduction, while an ETF comes with both the benefits.

The broad differences between ETFs and stocks are as below:

• Diversification

Diversification is a key benefit of investing in stock market ETFs, as they hold multiple securities, providing investors with greater diversification compared to individual stocks. 

While an investor may only invest in one stock of a particular sector, ETFs invest in multiple securities, allowing for greater risk reduction and diversification for investors.

• Risk Reduction

Investing in stock market ETFs is typically considered safer than investing in individual stocks because ETFs reduce risk for investors through diversification. This means that profits from some securities can compensate for losses in others, providing a more stable investment. 

In contrast, investing a significant amount in one stock increases the risk for investors, especially if the value of that stock experiences a significant decline.

• Professional Managers

Professional managers manage ETF investments, unlike long-term investment stocks that individuals manage. This means that investors can avoid the hassle of deciding when to buy or sell securities, as they can rely on the expertise of these managers to make those decisions on their behalf.

• Cost Comparison

While investing in stocks does not involve the cost of professional managers’ fees, ETF investments are overseen by these managers, which can result in additional fees. 

However, investors may still save on other costs, such as brokerage and other charges, when investing in ETFs.

• Taxation

Are ETFs better than Stocks?

Suppose a sector has minor deviations from the average return. In that case, ETF investments may be a better option than investing in individual stocks as it can provide similar returns to any stock returns. In such cases, the upside for the stock investor may not be significant, making ETF investment a preferred option.

Another scenario where ETF investments may be more suitable is when it’s difficult to ascertain the stock performance drivers. An investor may struggle to select a stock that consistently outperforms the sector, and ETF investments can offer a diversified approach that provides better investment returns.

For sectors with high volatility in individual stock returns, investing in Stock market ETFs is generally a better option as it reduces risk through diversification and provides stable returns. Additionally, some ETFs invest in companies within cyclical sectors, giving investors investment opportunities during the industry’s up-cycle.

Investors can decide on their preferred investment option based on the above factors.

Few of the best ETFs in India for the last 05 years: 

(Source: Factset)

Are Stocks better than ETFs?

Investing in stocks for the long term can often lead to better risk-adjusted returns and create wealth. Unlike ETFs, investing in the stock market may result in higher returns when there is a significant deviation from the mean returns in a sector. However, it’s crucial for investors to choose securities that outperform the ETF stocks.

Professional stock market investors who conduct thorough research may opt to invest in individual stocks based on their analysis of a particular company in a specific sector. Suppose the company has a consistent track record of providing good returns to investors and is expected to outperform the sector in the future. In that case, such investors may save on investment managers’ fees.

In India, some long-term stocks have a history of providing excellent returns to investors. A few of the best long-term stocks in India (NSE 50) are as below:

(Source: Equitymaster)

Conclusion

Investors can consider their preferences based on the above factors when deciding between investing in ETFs or stocks. WealthDesk provides investors with portfolios built by SEBI registered professional advisers, allowing them to invest in good long-term stocks and ETFs in India. 

Long-term investments in stocks and ETFs come with both upsides and downsides, and investors should aim to enhance their returns while limiting and managing associated risks.

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