Difference Between Stocks and ETFs

understand the difference between stocks and etfs and make an informed investment decisions

Do you find yourself confused between stocks and ETFs? You're not the only one. Many people who are new to investing are in the same boat. Both stocks and ETFs are well-known investing vehicles that serve different purposes.

Stocks represent a share of ownership in one company, while ETFs diversify that ownership through a portfolio of assets in one instrument. Understanding these differences is necessary to make an informed investment decision. This article discusses the difference between stocks and ETFs to help investors select the most suitable investment vehicle.

Table of Contents

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What are Stocks?

Stocks, often called "shares" or "equities," refer to ownership in a company listed on exchanges such as the NSE and BSE. When you purchase a stock, you become a part-owner of the company and may earn a return on that investment through rising stock prices or dividends. To raise cash, companies issue stocks.

Stocks can fluctuate based on market demand, company performance, or global events. Investing in stocks offers the potential for a higher return than safer investments, but carries much more risk.

What are ETFs?

An ETF, or Exchange-traded Fund, is an investment fund that can be bought and sold on a stock exchange like a regular stock. ETFs can contain one type of asset, such as stocks or bonds, but they often contain a combination, such as stocks, bonds, and commodities.

When you buy one ETF, you buy a collection of investments, i.e., stocks, bonds, and commodities. An example of an ETF is the Nifty 50 ETF, which tracks the performance of the Nifty 50 index and allows investors to buy or sell units on the stock exchange just like shares.

Key Differences Between Stocks vs ETFs

Although both are investment instruments, stocks and ETFs work quite differently. Knowing their nuances is key to effective personal finance decisions. Below is a table outlining their key differences:

Aspect Stocks ETFs
Definition Represents ownership in a single company. Represents a pooled investment fund comprising multiple underlying securities (such as stocks, bonds, and commodities).
Ownership Rights Includes voting rights and possible dividends from the company. It may include shareholder rights and dividends, depending on the ETF structure.
Diversification Returns are tied exclusively to the performance of one company for an investor. Provides instant diversification among multiple assets, including associated risk levels.
Risk Profile Higher risk is associated with the operating performance of one company. Lower risk is associated with compensated gains in other assets within the ETF.
Volatility Higher volatility, as investment returns solely depend on one company's performance. Lower volatility as a function of spreading risk across diversified investments in the fund.
Liquidity Most well-known stocks are liquid; however, it depends on the stock market's liquidity. Liquidity can vary based on the ETF size; larger ETFs tend to be more liquid than smaller ETFs.
Management Style Investing in stocks generally requires active decision-making to monitor and select stocks. An ETF can be either passively (index-based) or actively managed by fund managers.
Trading Flexibility You can trade during market hours and after hours for certain stocks. You can trade during market hours with real-time pricing, just like with stocks.
Cost Structure You may pay brokerage commissions for each transaction. No annual fees are involved. You will pay the expense ratios (annual fees) and possibly commissions for all trades.
Taxation Gains will be taxed at capital gains, and dividends will be taxed at income. Gains are taxed similarly to stocks. Gains incur taxation when sold, and dividends are taxable as income.
Return Potential If the company does well, there is substantial return potential and considerable downside risk. Returns can be steady, but they are solely tied to the performance of underlying assets and not intended to outperform the market overall.
Research Requirement Significant research is required into specific companies and sectors. You will spend time and effort doing this. Minimal research is required because ETFs automatically represent multiple assets.
Market Access You are limited to individual stocks or sectors chosen by the investor. You can access multiple markets, industries, and asset classes in a single product.
Suitability A good fit for trading investment products for an experienced investor, for potentially high returns while having a higher risk level. A good fit for a beginner investor or someone wanting lower-risk diversified portfolios, which can also be easier to manage overall.
Dividend Yields Dividend yields depend on the individual company. Some stocks offer dividend yields, others have none at all. ETFs may pay dividends based on the collective dividends of their underlying stocks, but yields may differ.
Voting Rights  Stockholders typically have direct voting rights in company matters. ETF investors do not have direct voting rights. ETF provider exercises voting rights on behalf of all investors.
Control Owning stocks gives shareholders some control through voting and influencing company decisions. ETF investors have no direct control over the underlying companies.

Types of Stocks

Stocks can be categorised into several types based on ownership rights, market capitalisation, sector, and investment style. Below is a detailed breakdown of the different types of stocks:

Basis of Classification Type of Stock Description
Ownership Common Stock Common stock signifies a stake in a company, including voting rights and potential dividends. Shareholders of common stock are entitled to capital appreciation.
Preferred Stock Preferred stock usually has fixed dividends and gives preferred shareholders the claim priority over common stockholders in the event of liquidation.
Market Capitalisation Large-Cap Stocks The shares of companies with a market capitalisation above ₹20,000 crores. Well-established businesses with stable growth patterns.
Mid-Cap Stocks Mid-cap stocks are shares of companies that have a market capitalisation between ₹5,000 crores and ₹20,000 crores.
Small-Cap Stocks Small-cap stocks are the shares of companies with a market capitalisation below ₹5,000 crores. These are typically younger companies.
Growth Potential Growth Stocks Firms’ stocks are expected to achieve revenue or earnings exceeding the market's average growth rate.
Value Stocks Stocks undervalued in terms of trading price are trading below their intrinsic value.
Dividend Stocks Stocks of companies that consistently return profits to shareholders by paying dividends.
Defensive Stocks Stocks in non-cyclical (compared to cyclical stocks) are specific companies that remain stable when the overall economy is poor.
Other Blue-Chip Stocks Blue-chip stocks are the stocks of financially sound, well-established companies that pay dividends and have steady and consistent earning potential.
Cyclical Stocks Stocks are tied to overall economic performance. They perform well when the economy grows, but poorly once a recession occurs.
Sector Stocks Stocks categorised by multiple industry sectors - technology, healthcare, finance, energy, etc.
International Stocks Shares of companies outside the investor's home country, including shares in emerging markets.

Types of ETFs

Exchange-traded Funds (ETFs) come in many types, each designed to meet specific investment goals. Given below are the major categories of ETFs:

Type of ETF Description
Stock Index ETFs Track stock market indices such as the S&P 500 and the Nasdaq 100. These ETFs offer broad exposure to the market.
Bond ETFs Invest in fixed-income securities such as government, corporate, or municipal bonds.
Commodity ETFs Invest in physical commodities such as gold, silver, oil, and agricultural.
Currency ETFs Follow the performance of foreign currency or currency pairs. Currency ETFs allow speculation about potential foreign currency exchange rates or hedge exposure to currency volatility.
Thematic ETFs Focus on themes such as clean energy, robotics, electric vehicles, cloud computing, or disruptive technologies.
Leveraged ETFs Use derivatives to magnify an index's daily returns by a multiplier (e.g., 2x or 3x). While long-term investors can utilise leveraged ETFs, they are more appropriate for active traders.
Inverse ETFs Provide returns that are opposite the performance of an index and allow an investor to benefit from a declining index.
International/Global ETFs Invest in stocks of companies located outside the investor's home country, including emerging markets.

Pros of Investing in Stocks and ETFs

Stocks and ETFs have unique advantages for investors wishing to build wealth. Key advantages include:

Aspect Pros of Stocks Pros of ETFs
Potential Returns Stock investments offer a significant opportunity for growth compared to other investment types, especially in capital gains over time. Investments in ETFs may offer steady returns, either by tracking indexes or by maintaining a diverse portfolio to diminish the risk of having a single stock.
Income from Dividends Many stocks offer dividend payments, regular income that can be reinvested for growth or used as passive income. Many ETFs are structured to pay dividends based on the stock they represent to serve as passive income.
Liquidity Stocks are the most highly liquid form of investment. During trading sessions, investors can buy and sell shares of stock on major stock exchanges. ETFs are also liquid investments. ETFs can be bought and sold like stocks on stock exchanges, priced continuously throughout the day.
Ownership Rights Investors who purchase stock obtain ownership and voting rights to influence company management and decisions. Investor participants own a portion of an ETF but do not have the right to vote on issues related to a specific company.
Diversification Purchasing multiple stocks to own a diverse portfolio, typically across several sectors or industries, can take significant effort and time to establish. ETFs provide immediate diversification across multiple assets, including stocks, bonds, commodities, etc. A diverse portfolio may take the edge off volatility and help simplify tracking and monitoring.
Cost Efficiency There are no annual management fees (although transaction fees may apply to each trade). ETFs usually have a lower expense ratio than mutual funds and provide a cost-effective investment opportunity in large market segments or industries.
Tax Efficiency Stocks are taxed on capital gains and dividends, and occasionally, investors can use tax-efficient strategies like holding to lower taxable events. ETFs are tax-efficient because of their structure and because they employ in-kind transactions when they rebalance portfolios, resulting in fewer taxable distributions.
Sector-specific Exposure Investors can identify specific sectors or industries by investing in stocks within those sectors (i.e., technology and healthcare). Sector ETFs are an easy way to access a sector or industry without needing to invest or purchase a stock, allowing for a more straightforward sector approach to investing.

Cons of Investing in Stocks and ETFs

While there are advantages to investing in stocks and ETFs, they are not without disadvantages. Below is a table comparing both investment types with their key disadvantages:

Aspect Cons of Stocks Cons of ETFs
Volatility and Risk Stock prices fluctuate widely depending on market conditions, company performance, and the global economy, leading to losses, particularly for shorter-term investors. ETFs tracking volatile indexes or sectors can also move significantly in price, but the benefit of diversification typically reduces this risk.
Tax Implications Stock gains are subject to capital gains taxes, which may inhibit investor returns. The rate at which stock is taxed depends on the holding period and account type. ETF structures are generally considered tax-efficient, but selling an ETF can incur capital gains taxes. However, ETFs' in-kind transaction structure also helps mitigate taxable distributions.
Liquidity Issues Some stocks, particularly small-cap stocks, can carry liquidity issues that may hinder the ability to buy or sell shares quickly with equal value. Larger ETFs typically offer good liquidity, whereas smaller, niche ETFs may have liquidity concerns, decreasing the investment efficiency in ETF trading.
Brokerage Fees Purchase and sale of a single stock typically incur brokerage commissions, and these costs generally reduce profits. ETFs also involve trade fees, which will be lower than alternative strategies such as actively managed mutual funds.

Which is Better Between Stocks or ETFs?

The choice between investing in individual stocks or exchange-traded funds (ETFs) ultimately depends on your financial goals, risk tolerance, and experience with investing.

1. Understand Your Investment Goals

If you want a higher return, you should invest in individual stocks. On the other hand, for those investors looking for diversification and less hands-on management, ETFs are best.

2. Evaluate Risk Tolerance

Individuals comfortable with the market's volatility and potentially large gains or losses may prefer to invest in individual stocks. Investors looking more for stability and a steady return are apt to invest in ETFs.

3. Evaluating Investment Experience

An individual with a fair amount of experience and understanding of market conditions may benefit from selecting individual stocks. The novice investor may benefit from investing in ETFs.

4. Considering Costs and Tax Implications

Although purchasing stocks tends to have lower fees, you must consider transaction costs and ongoing portfolio management. Although ETFs incur expense ratios, they are typically lower.

 

Selecting the most appropriate investing approach requires careful consideration of one's financial goals, risk tolerance, and time commitment. A good investing strategy is about progressing toward the investor's financial strategy. An informed decision-making approach helps to limit needless risks and increase the opportunity for future sustainable growth.

Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.

We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.

FAQs about the Difference Between Stocks and ETFs

What are stocks?

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Stocks are shares of ownership in a company. When you buy a stock, you partially own that company. Stocks often allow shareholders to vote on essential matters for the company and may earn dividends.

What are ETFs?

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ETFs (Exchange-Traded Funds) are typically investment funds that hold a basket of stocks, bonds, or commodities. They are traded on an exchange like stocks, and Investors can buy and sell their shares all day long, according to the exchange hours.

How do stocks and ETFs differ in terms of ownership?

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Stocks give you ownership in one company (with voting rights). ETFs give you ownership in a diversified portfolio of securities.

Which offers better diversification, stocks or ETFs?

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ETFs have better diversification because they spread your investment over more securities.  This diversification helps mitigate risk because the loss in one asset could be met with a gain in a different security.

What are the main risks associated with stocks?

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Stocks carry a higher degree of risk, specifically regarding how one company performs. Stocks also carry liquidity risk for smaller or less frequently traded companies, meaning it may be harder to sell stock quickly and obtain a fair price.

How do ETFs manage risk?

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ETFs mitigate risk by having a diversified underlying portfolio. When an ETF holds a diverse range of securities, it helps spread risk across many companies, sectors, or asset classes within the ETF's thematic framework.

Can I trade stocks and ETFs during the same hours?

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Yes, stocks and ETFs can be traded during the market's normal hours. Both ETFs and stocks are traded on exchanges and can be bought and sold during stock market hours, which allows investors to manage their portfolios while reacting to the market's changes in real time.

Which is more suitable for active trading, stocks or ETFs?

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For active trading, stocks would be the most suitable option as they can be much more volatile, and having the direct outcome of investing directly in a company's stock is quite favourable.

Do stocks and ETFs offer dividend income?

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Yes, both stocks and ETFs can pay dividends. Stocks are best known for paying dividends, which can provide investors with a steady stream of passive income. ETFs pay dividends from the income of the stocks or securities they hold. However, not all ETFs provide dividends.

How do stocks and ETFs differ in terms of liquidity?

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Stocks and ETFs are usually liquid. However, stocks tend to be more liquid due to higher trading volume. Large-cap stocks are particularly liquid. They are easy to buy or sell and at reasonable prices.

Are ETFs more tax-efficient than stocks?

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Yes, ETFs are usually more tax-efficient. This is because of their structure and the way they trade in-kind. ETFs rebalance their portfolios by swapping securities with investors. This method avoids selling the fund's assets, which helps limit tax events.

Can I invest in ETFs with a small amount of money?

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Yes, ETFs let you invest in fractional shares. This makes it easier to invest even with limited money. Many brokerage firms now let you own a fractional share of an ETF instead of a whole share.

How do I choose between stocks and ETFs based on my investment goals?

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Stocks work well for investors wanting high returns and direct company access. In contrast, ETFs offer diversified and stable returns. If you seek high growth for your investment and can manage some risk, stocks may be a better option. If you want a steadier investment, ETFs are a better choice.

Do I need experience to invest in stocks or ETFs?

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Investing in stocks often requires a more experienced investor who does thorough research. In contrast, ETFs are easier for novice investors to access.

Can I use ETFs for sector-specific investments?

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Yes, ETFs help investors access a market sector easily without buying individual stocks. Sector ETFs focus on specific sectors like technology, healthcare, or energy, making it easy for investors to invest in these areas.

Are ETFs suitable for long-term investments?

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Yes, ETFs are suitable long-term investments because they facilitate diversified investments cheaply. ETFs are a reliable way of investing in broad markets or specific sectors over time to lessen the impact of market fluctuations.

As a beginner, where should I invest in ETFs or stocks?

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ETFs are generally better for beginners because they offer diversification, lower risk, and require less research than picking individual stocks.

Which is riskier, ETFs or Stocks?

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Stocks are riskier than ETFs since your investment depends on the performance of a single company, while ETFs spread risk across multiple securities.

What is the primary difference between ETFs and stocks?

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The main difference is that stocks represent ownership in a single company, while ETFs are funds that hold a diversified basket of assets, reducing concentration risk.

Disclaimer

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  • This is an informative article provided on 'as is' basis for awareness purpose only and not intended as a professional advice. The content of the article is derived from various open sources across the Internet. Digit Life Insurance is not promoting or recommending any aspect in the article or its correctness. Please verify the information and your requirement before taking any decisions.
  • All the figures reflected in the article are for illustrative purposes. The premium for Coverage that one buys depends on various factors including customer requirements, eligibility, age, demography, insurance provider, product, coverage amount, term and other factors
  • Tax Benefits, if applicable depend on the Tax Regime opted by the individual and the applicable tax provision. Please consult your Tax consultant before making any decision.

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