ETFs Vs Stocks

I. What are the similarities and differences between ETF vs Stock?

A stock is one particular security that denotes the ownership of a fraction of a certain company, while an ETF is a basket of different securities and not necessarily only shares. For example, owning a share of Schlumberger, and owning a share of an energy sector ETF. There are similarities and differences between ETFs and Stocks.

For the similarities, both are traded intraday meaning that they are bought and sold throughout the normal trading hours, and they are price transparent in which their bid and ask price quotes and shares' volumes are shown in real-time, unlike mutual funds. An investor can also perform all market order types when acquiring the shares; in addition to, the ability to short sell both of them and use options. Finally, both offer dividends to their shareholders.

For the differences, a stock is riskier than ETF, since ETF is a basket of different securities in which a poor performance of one stock can be offset by the good performance of the many other stocks in the ETF. Also, it would be costly to buy several stocks independently from different industries to ensure the diversification of a portfolio, while a single ETF offers investors the chance to trade several stocks at much less cost. Also, ETFs offer market exposure to their investors to a wide range of sectors, and specific strategies such as growth and value stocks, but trading a single stock allows investors to focus on a specific firm. Easy management and less time consumption for the investors are other differences in which an investor decides on which company to invest in and how many shares to buy, while ETFs are managed by professionals who do all the research and buying and selling of the stocks in a single ETF; thus, saving a hassle for investors.


II. Is ETFs trading better than stock trading?

This question cannot be clearly answered because it depends on the investor's risk appetite and strategies; however, it is safe to say that stocks can offer higher returns to investors with a higher risk appetite. Stock trading can be advantageous if there is a wide dispersion of returns from the mean of the market, while ETFs are more advantageous when the stocks' returns in a sector have a narrow dispersion from the mean meaning the performance of the companies in the same sector is almost similar. ETFs can be a wise choice when it comes to a sector with complex technologies; for example, if it is expected that the biotechnology industry is booming, had an investor bought a stock of a certain company expecting high growth due to a specific drug, and the developed drug didn’t get approval, he or she would lose, but investing in the whole sector would be wiser in that case.


III. What is the downside of ETFs?

Like everything else that has its pros and cons, ETFs have their own drawbacks. Like stock trading, Investors pay a commission on each execution, and those costs might be high; hence, reducing an investor's return on investment (ROI). Also, some of them might have risky underlying strategies. Also, most ETFs include large-cap stocks leaving potential growing Medium and small enterprises out of reach. Although there are ETFs that provide dividends, the dividend yield is lower than that of a solitary stock, given the lower risk of ETFs.

Tracking error is the difference between the returns of the index fund and the tracked index.


IV. Are ETFs good for beginners?

ETFs could potentially be good investments for beginners because they are a good diversification strategy that lowers a portfolio's volatility, reaps the benefits of investing in a bigger portfolio, are easy to manage, and consume less time for the investors as an investor decides on which company to invest in and how many shares to buy, while ETFs are managed by professionals who do all the research and buying and selling of the stocks in a single ETF; thus, it is beginners-friendly. However, beginners should carefully scrutinize the targeted ETF because the myriad options can entice unwise decisions; some ETFs might be related to risky sectors or employ risky strategies; such as leveraged ETFs that owe their high gains to borrowed money and not to the good performance.


V. Is there a difference between how stocks and ETFs go up?

It depends on the nature of the underlying assumptions of the ETF; for example, if it's an ETF that mimics a specific index, they will move in tandem; however, if it's an inverse ETF they would move in different directions. Also, the magnitude of the rise would be different since an ETF includes several stocks and not only one.

The content published above has been prepared by CFI for informational purposes only and should not be considered investment advice. Any view expressed does not constitute a personal recommendation or solicitation to buy or sell. The information provided does not have regard to the specific investment objectives, financial situation, and needs of any specific person who may receive it, and is not held out as independent investment research and may have been acted upon by persons connected with CFI. Market data is derived from independent sources believed to be reliable, however, CFI makes no guarantee of its accuracy or completeness, and accepts no responsibility for any consequence of its use by recipients