If there’s one thing investors know, it’s that making the right choices is the aim of the game.
At some stage, every investor will confront two options: whether to invest in exchange-traded funds (ETFs) or stocks.
ETFs are a type of investment fund traded on stock exchanges. They are collections of stocks, bonds, currencies, futures contracts, or commodities, such as gold bars. They primarily operate with an arbitrage mechanism to keep them trading close to their net asset value. This fact generally makes ETFs a safe investment choice.
Stocks, or shares, are the parts of a corporation that are publicly available to buy, sell and trade on the stock exchange. Investors can own fractional portions of companies and corporations and therefore take on an interest in the company, resulting in profit or loss depending on how well the company performs.
Since ETFs and stocks are both popular investor choices, many investors, especially those new to the game, are undecided on which one suits their portfolios best.
Fortunately, that’s all about to become a lot clearer. Let’s begin by highlighting the three key differences between ETFs and stocks.
- ETFs are professionally managed and pooled investments from a wide variety of sources.
- ETFs are generally less risky because all your eggs are not in one basket, but this isn’t always an indicator of less risk.
- ETFs are less liquid, but this isn’t always the case, and their liquidity largely depends on the type of fund.
- Stocks are the individual shares of a company that can be bought, sold, and traded on the stock exchange.
- Since they are linked to one company’s performance, stocks can be riskier investments.
- Stocks are more liquid, but again, this largely depends on the type of stock and its affiliated regulations.
While stocks and ETFs are assets (something of value that is owned) and securities (assets that can be traded), their core structures are different.
Stocks give an investor a piece of a company made available to help the company build funding for growth and development. They can be traded openly, subject to legislative rules, and individual investors use their knowledge to buy certain stocks when they feel the price is right, only to trade or sell when they think they can make a profit.
Of course, things can go wrong, and companies lose value and go under every day. Essentially, as an investor, you are taking a risk by investing in stocks because, ultimately, the company’s success depends on many outside factors.
ETFs are structured, created, and managed by professional ETF managers who organize the fund to make it attractive to potential investors. These collections of funds are known as baskets. Sometimes the baskets will be in line with certain stock indexes or industry sectors, depending on the fund’s investment goals.
Any investment has its fair share of risk, which is part of the appeal since where there is risk, there is often reward.
As any investor knows, the more diverse an investment, the less risk the investment poses. ETFs are essentially a diversified basket of assets and are generally less risky than stocks.
The downside is that, while ETFs tend to be safer, they also tend not to rise in value as dramatically as stocks.
As with all investments, you need to determine the risk versus reward and make your choice based on what’s best for you.