The best way to invest is with a diverse portfolio. There are many asset classes you can choose from, whether they are stocks, bonds, indexes, real estate, or even cryptocurrencies. When investing, it’s crucial to learn and understand the different types of asset classes and how holding them can affect your portfolio.
Some asset classes are perfect for long-term holding, while others are preferred for short-term or day trading, like stocks and cryptocurrencies. In the stock market, you have two main types of investment products with different characteristics and risk assessments: Stocks and ETFs.
What are Stocks?
A stock (also known as shares) is the fractional ownership of a company listed on a stock exchange. A stock exchange is an institution that lists various large corporations where shares in each corporation trade daily.
Companies issue shares to raise capital to initiate new projects, or expand operations. With your investment in the company, not only are you given voting rights on certain company dealings, but you also get a share of the profits. A share of profits is called a dividend, which pays shareholders either quarterly, every six months, or annually.
One thing to note is that stock ownership does not give your direct ownership in the company. Limited liability companies are “legal persons,” as these companies can own assets, borrow money, and get sued. If a company goes bankrupt, the personal assets of the shareholders are not affected.
There are two common types of stocks:
- Common stocks: stocks you buy and trade for profit or dividends
- Preferred stocks: simply common stocks where shareholders receive higher dividend payouts before common shareholders
What are ETFs?
An ETF (Exchange-Traded Fund) is a collection of different stocks under one name. ETFs can contain a small number of hundreds of individual shocks from either similar or diverse sectors.
ETFs allow an investor to gain exposure to many different companies without directly owning each share. Companies do not issue ETFs but are created by financial institutions, asset management firms, or brokerage.
When an institution or brokerage creates an ETF, they purchase different stocks and bundle them together to sell to investors. When you purchase an ETF, you are entitled to a share in the profits of the ETF.
One of the advantages of ETFs is that your investment is not linked to only one company. If, for example, an ETF holds 10 companies and one loses most of its values, the other nine companies will keep your investment steady. ETFs can safeguard your portfolio from most volatility.
Below is a table outlining some of the main differences between Stocks and ETFs
Higher cost to diversify
More diversity with a single purchase
Direct exposure to a single company
Broader market exposure
Personal research and decision making
Professionally managed by a broker
A single type of asset class
Can hold multiple asset classes
To Wrap Up
Stocks and ETFs are similar asset classes but offer investors differences in risk exposure and profitability. Both are ideal for a diverse investment portfolio.