The difference between Exchange Traded Funds (ETFs) and stocks can be easily understood by drawing an analogy. Stocks could be considered as that single dish you order when visiting a multicuisine restaurant. On the other hand, ETFs are like sitting for a buffet.
What is an ETF?
ETF is a basket of securities that contains various stocks, bonds, commodities, and other securities as per the structure set by the fund manager. If you buy 1 unit of ETF, you are eventually buying a fraction of each component. The focus of each ETF can be different.
What is a stock?
Stock is a share of the ownership in a company. If there are 1,00,000 shares issued by the company and you hold 5,000 shares, you are 5% owner of the company. Companies issue stocks first through an IPO (Initial Public Offer). Later on, these stocks are available for trade in the market segment.
How are ETFs different from stocks?
|ETFs provide a lot of diversifications into various instruments
|You won’t get the benefit of diversification here since you hold the stock of a single company. Even if you hold stocks of different companies, the resultant diversification would be lower than that of ETFs
|Risk is lower compared to stocks as ETFs are a pool of several securities
|Could be riskier as the performance of a stock is tied to the performance of that one company, no diversification to mitigate risks
|A fund manager analyses the components of an ETF and works towards keeping the fund aligned with the scheme objective
|You have to put in efforts from choosing the stock to analysing the same
|The expense ratio and brokerage fee are lower in ETFs. The expense ratio includes administration and fund manager fees. Since the expense is divided into various units, individual expenses are lower
|Comparatively, the brokerage is a little higher
|A fund manager guides your decisions to select the best ETF
|You have to make your own decision for the selection of stock
|Approach of the investor
|You could stay passive here
|You need to be active here
|You are exposed to various industries and different business cycles. Thus, the risk is mitigated.
|If you have invested in only one company, you are exposed to only one industry. Thus, the risk is higher.
Are ETFs better than individual stocks?
The phrase “one size fits all” does not apply when it comes to investing in ETFs or stocks. Each investor has their own risk and returns profile. It depends on what your investment strategy is. Investing in ETFs can be attractive to you as an investor if you have a lower risk appetite.
- ETF funds are managed by professionals, but the same is not the case with individual stocks. You have to answer a few questions before you arrive at a decision –
– Time horizon of investment
– Acceptable risk and required returns
– Whether your approach of investment is passive or active
– Purpose of investment
There cannot be a blanket rule for investing only in ETFs or only in stocks. A weighted mix of both instruments could help you better manage the risk. For example, if you have Rs. 50,000 to invest, you may consider, say 60% in ETFs and the balance 40% in stocks. It all depends on your risk-return objective.