ETFs vs Stocks: Which are Better?
As a beginner investor, deciding the best investment for you can be challenging. There are thousands of choices, and picking the wrong asset can be detrimental to your wallet and future.
Every investor has a different life and story. Therefore, everybody’s investment goals will differ; you can’t use a one size fits all approach to investing.
Investors who want to take on a lot of risk may want to concentrate their portfolio on a few single companies to maximize return potential. On the other hand, a more risk-averse investor may want to invest their money into a diversified stock portfolio through an index fund or ETF.
Exchange-traded funds (ETFs)
An ETF is a financial product you can easily invest in to create a diversified stock portfolio. Investing in an ETF is like putting your money in a basket of stocks in one purchase. Allowing you to invest passively without having to worry about picking individual stocks.
Index funds
Index funds are funds that track a specific index. You put your money into one, and the fund will track the performance of a specific market index, such as the popular S&P 500 Index, as closely as possible. Various types of ETFs will allow you to invest in specific sectors, indexes, or investment strategies.
Common types of ETFs
There are many types of funds you can invest in, depending on what your investing goals are.
REITs
Real estate investment trusts are funds that allow you to gain exposure to real estate within the stock market. REITs are great for investors who enjoy dividend payments and passive real estate investing.
Sector
Sector funds allow you to invest in a specific stock market sector, such as utilities or technology.
Total stock market
Total stock market funds invest in every stock on the market. Therefore, total stock market funds are the most diversified you can get.
S&P 500
The S&P 500 is a popular stock index that tracks the top 500 companies on the stock market.
Nasdaq 100
The Nasdaq 100 is another popular index that invests in the largest 100 companies on the stock market.
You can read more about my favorite ETFs to buy and hold here.
Individual stocks vs ETF risks and benefits
Individual stock investing and ETF investing have their benefits and risks against each other. Depending on your risk tolerance and goals, one might be a better investment for you. To help you decide, let’s break down the benefits and downsides of individual stocks and ETFs.
Benefits of individual stocks
Higher return potential
Individual stock investing is inherently riskier because you have to keep track of how the company is doing and decide when to buy and sell.
You have more control
When building a portfolio of individual stocks, you are essentially creating your own ETF. However, if you have thoroughly researched the companies in your portfolio, there’s a chance you will outperform ETFs with similar holdings.
Downsides of individual stocks
Individual stocks may not perform well
No matter how much research you have done on a company, it can always fail or underperform. Understanding technical analysis can help you identify the start of a downtrend.
Individual stocks can go out of business
Companies that are safe today may be bankrupt tomorrow. You never know what will happen in the stock market, and any company can go out of business.
Potentially company-specific news
Sometimes companies can get bad news that only affect them while the rest of the sector is fine. If bad news comes out on your stock, it will not be fun to watch your stock underperform an ETF.
Benefits of ETFs
ETFs are passive investments.
You never have to monitor stock positions as an ETF investor, making them great passive investments.
Broad market ETFs have always recovered.
Unlike individual stocks that can go bankrupt and underperform, ETFs have proven to always recover to all-time highs.
If a company goes bankrupt within an ETF, the other companies will generally pick up the slack minimizing the impact on your portfolio.
Bad companies are automatically removed.
If a significant holding in an ETF were to stop performing well, the index or fund manager would automatically remove and replace it for you.
Downsides of ETFs
Lower profit potential
Investing in ETFs is less risky and passive, but there is less return potential.
Fees
ETFs charge fees called expense ratios, while individual stocks do not. The expense ratio differs by ETF, but many ETFs have low expense ratios under 0.10%.
Can’t control as much
If you don’t like a few of the holdings with an ETF, you can’t remove them from the fund. ETF investors are at the mercy of the index and fund manager.
ETF vs Stocks: Which Should You Pick?
The difference between stocks and ETFs primarily depends on your overall investing goals. Risk-averse investors will lean toward ETFs, while investors with a risk appetite will likely choose individual stocks.
Why not both?
Many investors implement ETFs and individual stocks into their portfolios. A good combination of both is an excellent formula for a balanced portfolio. For example, you can allocate 80% to ETFs and 20% to individual stocks to manage risk and make significant returns over time.
An 80/20 allocation is just one example to give you an idea of how to structure your portfolio. Of course, everybody has an ideal outcome in the stock market, so you must decide what to do based on your personal investment goals.
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As Always: Buy things that pay you to own them.
-Josh
Blog Post: #036
