While both stocks and exchange-traded funds (ETFs) share an underlying asset, they’re entirely different types of investments.
Deciding how ETFs vs. stocks fit into your portfolio will depend on your goals and investment style.
ETFs vs. stocks
When you purchase stocks, you’re investing in individual companies. With ETFs, you’re buying a collection of stocks (and/or bonds) wrapped into a single product.
An ETF is generally a less volatile investment than individual stocks because, as a basket of multiple assets, it offers instant diversification.
If one or two stocks within an ETF drop in value, others may stay steady or increase in value, which balances out the overall impact on your portfolio. However, if you invested in just a few individual stocks and they decreased in value, your portfolio could see a major hit.
Research and management
Some people will dive deep into a company’s financials before investing in its stocks, while others may pick stocks based on a hunch. Then, once purchased usually need to actively manage the stock investments you’ve made.
ETFs, on the other hand, are created by a fund provider and typically track an index or sector. This is known as passive investing, and it can be attractive to investors since it’s mostly hands-off.
When purchasing ETFs and stocks, the process is fairly similar. Both can be purchased on your own through a discount brokerage account. Although the fees to buy both investment products are similar, people investing in ETFs typically spend less in fees because they’re making fewer trades.
ETFs can be purchased through robo or investment advisors. However, while some advisors can invest in stocks on behalf of their clients, those services are typically only offered to high-net-worth individuals.
Should you invest in ETFs or stocks?
The decision to invest in ETFs vs. stocks is often a personal choice. There’s no right or wrong answer, as they’re two different investing options. Also, you don’t necessarily need to pick one over the other. Investing in both ETFs and stocks can make sense in many cases.
When ETFs make sense
ETF investing is ideal for people who want to keep things simple. Even though there are hundreds of ETFs to choose from, there’s one designed for just about every scenario. For example, if you’re looking to grow your money, you can select an ETF with a higher allocation towards stocks. On the other hand, if you’re approaching retirement, you could consider ETFs focused on preserving capital.
Since ETFs typically track an index or sector, you’ll only earn average returns. Some people may see this as a negative, especially if they’re focused on aggressive growth, but accepting average returns is an acceptable strategy since your money may still grow.
More importantly, ETFs require little effort on your end. Most ETFs use algorithms, so all the buying and selling is done automatically. ETFs do charge a management expense ratio (MER), which is typically lower than that of mutual funds. However, investing in stocks doesn’t come with an MER.
When stocks make sense
Stocks will appeal to investors who are looking for complete control over their portfolios. You get to choose which stocks you buy and sell. This strategy may require more work, as you may need to study the company’s financials and other factors before starting to invest.
As a stock owner, you may get shareholder rights such as proxy voting. This gives you a real opportunity to have a meaningful impact on companies or sectors that you feel strongly about.
What makes individual stocks appealing to some investors is that there’s always a chance you could pick a winner that sees massive gains. In addition, when you choose stocks, you have the potential to earn higher-than-average returns. That said, investing in stocks also carries more risk than investing in ETFs. The stocks you choose aren’t guaranteed to outperform ETFs — or to increase in value at all.
When to consider investing in both ETFs and stocks
While some investors may prefer one investment product over the other, they may still invest in both. For example, an investor who prefers ETFs may still purchase individual stocks of specific companies they’re interested in. As for stock investors, they may also buy ETFs as a way to diversify their portfolios into sectors with which they’re not as familiar.
Another example would be an investor who prefers ETFs but has a company stock plan and wants to take advantage of this benefit.
Both ETFs and stocks can be easily purchased online brokerage accounts. Discount brokerages have affordable fees and tools available to help investors learn.
Regardless of what you decide to invest in, you’ll want to put in the time and energy to research your options so you understand what you’re purchasing and how it fits into your portfolio and overall investment strategy.