Stocks Vs. ETFs: Which Should You Invest In? | Bankrate (2024)

If you’re getting started investing, you might wonder whether it’s better to invest in stocks or ETFs. Well, the answer depends. Stocks can be a great investment in some circ*mstances, while ETFs can be better in others. But for new investors, exchange-traded funds solve many problems, and they’re an easy way to earn attractive returns — so they’re a great starting point.

Here’s all you need to know about stocks vs. ETFs and when it’s best to use each one.

Differences between stocks and ETFs

Stocks and ETFs are similar in some ways, not surprisingly, since ETFs often contain many stocks. Despite their likenesses, they’re fundamentally different and present various upsides and risks.

Stocks

A stock represents a fractional ownership interest in a business and typically trades on an exchange, in the case of a publicly traded company. When you own a stock, you’re investing in the success of that company — and only that company.

In the short term, stocks may rise and fall for many reasons, and market sentiment often determines how a stock performs day to day. In the long term, however, a stock more closely follows the company’s growth. As the company expands its profits, the stock will tend to rise as well.

Individual stocks can perform phenomenally over time, but they may be volatile in the short term, fluctuating massively. It’s not unusual for high-flying stocks to decline 50 percent in a given year on their way to long-term outperformance. On the other hand, a strong stock might go up 50 percent or more in a single year, especially if the overall market is hot.

ETFs

ETFs are collections of assets, often stocks, bonds or a mix of the two. A single ETF might own dozens, sometimes hundreds, of stocks. So by owning a single share of the ETF, investors can own an indirect stake in all the stocks (or other assets) held by the fund. It’s a great (and often inexpensive) way to buy a collection of stocks.

ETFs often invest in stocks that have a specific focus area, for example, large companies, value-priced stocks, dividend-paying companies or those operating in a specific industry, such as financial companies. Some specialized ETFs allow you to potentially earn higher returns.

Most ETFs are passively managed, meaning that they replicate a specific index of assets, such as the , a collection of hundreds of America’s largest companies. The ETF changes its holdings only when the underlying index changes its constituents.

Because of their wide array of holdings, ETFs provide the benefits of diversification, including lower risk and less volatility, which often makes a fund safer to own than an individual stock.

An ETF’s return depends on what it’s invested in. An ETF’s return is the weighted average of all its holdings. So if it owns many strong stocks, the ETF will rise. If it owns many poorly performing stocks, then the ETF will decline, too.

The table below shows some of the key differences between stocks and ETFs.

CharacteristicStocksETFs
Potential upsideHighLow-high, depending on the investment
RiskHighLow-high, depending on the investment
LifetimePotentially infinitePotentially infinite
Brokerage commissionsNo commission at major online brokersNo commission at major online brokers
When you can tradeAny time the market is openAny time the market is open
TaxCan be taxed at short-term or long-term capital gains rates, depending on holding periodCan be taxed at short-term or long-term capital gains rates, depending on holding period

The pros and cons of stocks

Investing in a stock can offer a lot of benefits, though it’s not without some serious drawbacks.

Advantages of investing in stocks

  • Investing in an individual stock can deliver very high returns, and you won’t be taxed on any capital gains until you sell, in a taxable account.
  • A single stock can potentially return a lot more than an ETF, where you receive the weighted average performance of the holdings.
  • Stocks can pay dividends, and over time those dividends can rise, as the top companies increase their payouts.
  • Companies can be acquired at a substantial premium to the current stock price.
  • Commissions on stock trading have been slashed to zero at major online brokers, meaning it doesn’t cost anything to get in and out of an investment.
  • Investors who hold a stock for more than a year may enjoy lower capital gains tax rates.
  • You can still own the wealth-building power of stocks within an ETF or mutual fund.

Disadvantages of investing in stocks

  • Stocks can fluctuate a lot from day to day and month to month, meaning you may need to sell at a loss and may never recover what you invested.
  • Volatility can be dangerous for investors who have all their wealth tied up in just one or a few stocks. If that one stock does poorly, the investor has a lot of eggs in one basket and can lose a significant portion of wealth.
  • Stocks aren’t an investment guaranteed by the government, so you may lose all your money.
  • Because an individual stock tracks the performance of the company over time, you have to own a winning company to make money. Pick a loser and you’ll lose money.
  • Much effort is required to analyze and value individual stocks, and many people simply don’t have the available time or desire to do so.
  • You’ll need to pay taxes on any capital gains you generate, though you also have the ability to write off losses and get a tax break.

The pros and cons of ETFs

ETFs offer plenty of benefits to investors, whether they’re new to the game or are more advanced, though these funds don’t come without some drawbacks.

Advantages of investing in ETFs

  • ETFs allow you to buy one fund and have a stake in dozens or even thousands of companies.
  • Because of this broad ownership, ETFs offer the power of diversification, reducing your risk and increasing your returns.
  • A well-diversified ETF such as can beat most investors over time, making it easy for regular investors to do well in the market.
  • ETFs tend to be less volatile than individual stocks, meaning your investment won’t swing in value as much.
  • The best ETFs have low expense ratios, the fund’s cost as a percentage of your investment. The best may charge only a few dollars annually for every $10,000 invested.
  • ETFs can be bought and sold any time the market is open, giving you a highly liquid asset.
  • ETFs can be traded at no cost at most major online brokers.
  • It takes little investing expertise to invest in ETFs and earn high returns.
  • You won’t be taxed on any capital gains until you sell the ETF in a taxable account.
  • Like stocks, ETFs can pay dividends.

Disadvantages of investing in ETFs

  • ETFs, even in a good year, will underperform the best stocks in the fund, meaning investors could have owned just those stocks and done better.
  • ETFs do charge an incremental cost, the expense ratio, for owning the fund.
  • Not all ETFs are the same, so investors do have to understand what they own and what it could return.
  • Like stocks, the investment performance of ETFs isn’t guaranteed by the government and you could lose money on the investment.
  • You can’t control what’s invested in any single fund, though of course you don’t have to buy shares in that fund either.

ETF vs. stock – which is better for you?

Buying individual stocks or ETFs can work better for individual investors in a variety of scenarios, and here’s when each one shines:

When stocks are better

  • You enjoy analyzing and following individual companies and are comfortable with it. It takes a lot of work to follow a stock, understand the industry, analyze financial statements and keep up with earnings. Many people don’t want to spend this time.
  • You want to find outperformers. If you can find the stocks that will outperform — for example, Amazon or Microsoft — you can beat the market and most ETFs.
  • You’re an advanced investor with time to devote to investing. Many investors enjoy following companies and tracking them over time. If that’s you, then investing may be a great option for you.

When ETFs are better

  • You don’t want to spend much time investing. If you’re looking for an easy solution to investing, ETFs can be an excellent choice. ETFs typically offer a diversified allocation to whatever you’re investing in (stocks, bonds or both).
  • You want to beat most investors, even the pros, with little effort. Buy an ETF based on the S&P 500 and you’ll wind up beating the vast majority of investors over time. That’s right, passive investing with ETFs generally beats active investing.
  • You don’t want to analyze individual companies. If you have no desire to follow business, then pick an ETF or a few, and add to them over time.
  • You’re a new or intermediate investor. ETFs are great for investors who are getting started, helping reduce your risk as your knowledge gets up to speed. But even many advanced investors use them, too.
  • You want to invest in a specific trend without picking winners. Is there a hot new industry but you’re unable to pick which company will come out on top? Buy an ETF and get exposure to the whole sector at low cost.

Of course, it’s possible for investors to do both of these strategies. For example, you could have 90 percent of your portfolio in ETFs and the remainder in a few stocks that you enjoy following. You can hone your skills at investing in individual stocks without hurting your returns much. Then, when you’re ready you can shift to more individual stocks and away from ETFs.

Bottom line

ETFs make a great pick for many investors who are starting out as well as for those who simply don’t want to do all the legwork required to own individual stocks. Though it’s possible to find the big winners among individual stocks, you have strong odds of doing well consistently with ETFs. Of course, you can blend the two methods as well, getting the benefits of a diversified portfolio with the potential extra juice from a few individual stocks on the side, if you want to try your skill.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.

Stocks Vs. ETFs: Which Should You Invest In? | Bankrate (2024)

FAQs

Is it better to invest in stocks or ETFs? ›

Stock-picking offers an advantage over exchange-traded funds (ETFs) when there is a wide dispersion of returns from the mean. Exchange-traded funds (ETFs) offer advantages over stocks when the return from stocks in the sector has a narrow dispersion around the mean.

Why not to invest in ETFs? ›

ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.

Which is riskier stocks or ETFs? ›

ETFs are less risky than individual stocks because they are diversified funds. Their investors also benefit from very low fees.

Is it better to buy individual stocks or index funds? ›

Investing most or all your money in individual stocks is risky and can lead to losing your investment capital. Investing exclusively in index funds is risk averse and offers much less in the way of returns. Ideally, you want to keep most of your investment dollars in safer investments such as index funds.

What is the downside to an ETF? ›

For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.

Is it OK to just invest in ETFs? ›

ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.

Has an ETF ever gone to zero? ›

Theoretically, for exotic ETFs, yes — but as a practical matter highly unlikely. And for broad market ETFs that track something like the S&P 500 Index the probability of going to zero is, well, about zero. Every stock in the index would have to go to zero.

Why am I losing money on ETFs? ›

Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.

Is it smart to only invest in ETFs? ›

ETFs can be a great investment for long-term investors and those with shorter-term time horizons. They can be especially valuable to beginning investors. That's because they won't require the time, effort, and experience needed to research individual stocks.

Are stocks safer than ETFs? ›

A single ETF can contain dozens or hundreds of different stocks, or bonds or almost anything else considered an investable asset. Since ETFs are more diversified, they tend to have a lower risk level than stocks.

What is the safest ETF to buy? ›

Funds 1-5
  1. Vanguard S&P 500 ETF (VOO 0.87%) ...
  2. Vanguard High Dividend Yield ETF (VYM 0.87%) ...
  3. Vanguard Real Estate ETF (VNQ 0.89%) ...
  4. iShares Core S&P Total U.S. Stock Market ETF (ITOT 0.96%) ...
  5. Consumer Staples Select Sector SPDR Fund (XLP 0.95%)

Are ETFs good for beginners? ›

The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.

Should I invest in S&P 500 or individual stocks? ›

Choosing your investments

Once you've opened an investment account, you'll need to decide: Do you want to invest in individual stocks included in the S&P 500 or a fund that is representative of most of the index? Investing in an S&P 500 fund can instantly diversify your portfolio and is generally considered less risky.

Is S&P 500 better than stocks? ›

Is Investing in the S&P 500 Less Risky Than Buying a Single Stock? Generally, yes. The S&P 500 is considered well-diversified by sector, which means it includes stocks in all major areas, including technology and consumer discretionary—meaning declines in some sectors may be offset by gains in other sectors.

Why invest in index funds instead of stocks? ›

Lower costs: Index funds typically have lower expense ratios because they are passively managed. Market representation: Index funds aim to mirror the performance of a specific index, offering broad market exposure. This is worthwhile for those looking for a diversified investment that tracks overall market trends.

Should you invest in both ETFs and stocks? ›

The bottom line. An investor looking to build a well-diversified portfolio doesn't have to choose between stocks and ETFs. Instead, understanding the different investment options, tax implications and more can help you build a strategy to meet your financial goals.

Why are ETFs less risky than stocks? ›

Diversification. One ETF can give investors exposure to many stocks from a particular industry, investment category, country, or a broad market index. ETFs can also provide exposure to asset classes other than equities, including bonds, currencies, and commodities. Portfolio diversification reduces an investor's risk.

Is it better to hold mutual funds or ETFs? ›

The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.

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