ETFs vs Stocks: Pros & Cons of Individual Stocks vs. Funds (2024)

Most investors typically have the same goal, to reach alpha. Alpha is an investment term used to describe a strategy that is outperforming the market and resulting in excess returns.

In other words, people invest to see their money grow and to generate wealth. There are several investing tools and strategies to consider if you’re looking to make an active return and one of the most common options is ETFs.

ETFs are exchange-traded funds and they are similar to stocks but also have some key differences. Let’s have a breif look at what ETFs and stocks are, and dive into their key differences and how these two options impact your investment strategy.

ETFs vs Stocks: Pros & Cons of Individual Stocks vs. Funds (1)

ETFs vs Stocks: Pros & Cons of Individual Stocks vs. Funds (2)

Find the right financial advisor with WiserAdvisor

Find the right financial advisor with WiserAdvisor

Description

Matching service to connect you with the best financial advisor for your needs.

Benefits

1. Personalized match with up to 3 vetted advisors;
2. Calculators to help financial planning;
3. Free initial consultation;
4. Location-based directory lists of top advisors.

Cost

Free

What is an ETF?

An ETF, short for exchange-traded fund, represents a unique investment vehicle with distinct characteristics. ETFs are traded on stock markets and allow investors to acquire shares through taxable brokerage accounts or retirement funds. These investment options have gained popularity among novice investors due to their abundant availability.

In essence, an ETF can be likened to a well-diversified assortment of investments. For instance, an ETF may constitute of a blend of high-value stocks, municipal bonds, and exposure to precious metals. By purchasing shares of an ETF, investors obtain fractional ownership of the underlying investments, based on the specific composition of the fund.

The process of purchasing ETFs is relatively straightforward. They can be acquired in a manner akin to buying stocks, with a wide array of choices at hand.

What is a stock?

A stock is a form of ownership in a publicly-traded company, providing investors with rights and benefits such as dividends and voting privileges.

The nature and investment potential of stocks lie on their various characteristics, including ownership, dividends, risks and returns, classes, their market cap, sector and industry.

In addition, stocks can exhibit different levels of price volatility (some having significant price swings compared to others) and liquidity (some can be easily bought or sold compared to others).

Within the stocks' two most common categories - common stocks and preferred stocks, many other types exist.

Key differences between stocks and ETFs

Stocks represent a piece of ownership in a publicly traded company. ETFs are a bundle of assets and securities such as different stocks and bonds. 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. Similar to stocks, ETFs can be bought and traded at any time and they are also taxed at short-term or long-term capital gains rates.

The assets inside an ETFs are bought and pooled together by the fund’s managers. Shares of the fund itself are then an ETF bought and sold by investors on a stock market, like the New York Stock Exchange.

ETFsStocks

Group of securities including stocks and bonds.

Individual shares of a company.

Risk is more diversified than a single stock, but not without risk.

Risk depends on the fortunes of the company.

Can be more illiquid (depending on the fund).

More liquid.

The pros and cons of stocks

Pros:

  • Returns can be higher than ETFs: Even though stocks are generally a riskier investment, the returns can be greater, especially if the company is growing quickly.
  • Commission-free trading options: There are many commission-free options that allow you to trade stocks without spending an extra penny.
  • You’re not paying someone to manage your stocks because you are the manager.

Cons:

  • Riskier investment: Investing in stocks is seen as a riskier investment than in a diversified fund because your capital is tied to the fortunes of a single company. With ETFs, especially indexed ETFs that contain tens or hundred of companies’ stocks, there is more diversity to help mitigate your risk.
  • More effort: Picking winning stocks requires more effort in research and paying attention to continuing performance.

The pros and cons of ETFs

Pros:

  • More diversified: With ETFs, you can buy one fund and gain access to stocks for several companies.
  • Reduced risk: Since you’re investing in a variety of assets, ETFs can reduce your risk since you aren’t putting your eggs in one basket.
  • As convenient as trading stocks: Buying shares of ETFs is as easy as buying shares of stock, and you can do it from your taxable brokerage account or a retirement account.

Cons:

  • Less control over what you’re investing in: Since ETFs are pre-selected investment funds, you can’t pick and choose which specific stocks or bonds you’re investing in.
  • May underperform stock investments: Even in a good year, an ETF based on a basket of stocks can underperform a single stock investment that is outperforming the market.
  • Management fees: Even index ETFs have management fees, and actively traded ETFs’ management fees can be quite high. The management fee takes money out of your total return.

When picking stocks might work

Following stocks and analyzing the market takes a lot of time and effort. You’ll want to stay on top of market news, company updates, and really expand your knowledge on picking stocks in general. Famous stock investors like Warren Buffett usually give similar advice: buy shares of companies with a great business model, solid earnings and excellent management.

It’s impossible to tell the future or guarantee how certain stocks will perform. However, you can find some companies you feel comfortable investing in that have proven to be successful historically. This hands-on strategy could outperform the returns from ETFs if you’re able to be dedicated to it.

When an exchange-traded fund (ETF) might be the Best choice

Investing in ETFs is the better choice if you want to diversify your holdings to reduce risk. Perhaps you’re not interested in poring through company quarterly reports and investing newsletters and would rather have someone else pick and manage your holdings.

ETFs still perform well and can even beat out stocks and hands-on investors with very little effort on your part. You should still be willing to research different ETF options, but you don’t have to be so concerned about picking “winners” as such.

With either stocks or ETFs, you do want to get advice from a financial advisor to help you not only pick investments but also manage your tax exposure and your long-term strategy and goals. WiserAdvisor can point you to a qualified professional to guide you.

ETFs vs Stocks: Pros & Cons of Individual Stocks vs. Funds (3)

ETFs vs Stocks: Pros & Cons of Individual Stocks vs. Funds (4)

Find the right financial advisor with WiserAdvisor

Find the right financial advisor with WiserAdvisor

Description

Matching service to connect you with the best financial advisor for your needs.

Benefits

1. Personalized match with up to 3 vetted advisors;
2. Calculators to help financial planning;
3. Free initial consultation;
4. Location-based directory lists of top advisors.

Cost

Free

Stocks and ETFs aren’t either/or, they’re both/and

When it comes to stocks vs. ETFs, one is not better than the other. They are both solid ways to invest your money depending on your interest and goals. In fact, you can do both to further diversify your portfolio.

Knowing how both stocks and ETFs work as well as the core differences between the two can help you make a wise decision for your strategy.

Frequently asked questions (FAQs)

Are ETFs good for beginners?

ETFs are a solid option for beginners due to their low expense ratio and diversity. ETFs are also a more liquid investment and have a very low investment threshold.

Do I need to pay taxes on ETFs?

Yes, when you sell shares of an ETF for profit, you’ll owe taxes on the “realized gain.” A realized gain is a return on an investment that indicates it was sold at a higher price than what it was originally paid for. You may also have to pay taxes on income from an ETF if it pays a dividend.

The information presented here is created independently from the TIME editorial staff. To learn more, see our About page.

ETFs vs Stocks: Pros & Cons of Individual Stocks vs. Funds (2024)

FAQs

Is it better to invest in ETFs or individual stocks? ›

Advantages of investing in ETFs

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.

Why is ETF not a good investment? ›

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.

What is the primary advantage of a mutual fund or ETF compared to an individual stock? ›

ETFs (exchange-traded funds) and mutual funds both offer exposure to a wide variety of asset classes and niche markets. They generally provide more diversification than a single stock or bond, and they can be used to create a diversified portfolio when funds from multiple asset classes are combined.

What are the disadvantages of ETFs? ›

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.

What is the primary disadvantage of an ETF? ›

Buying high and selling low

At any given time, the spread on an ETF may be high, and the market price of shares may not correspond to the intraday value of the underlying securities. Those are not good times to transact business.

Does it make sense to buy individual stocks? ›

Picking individual stocks can lead to more upside but requires that you monitor your portfolio more often. Most funds have several dead stocks that aren't doing much for total returns. Investing in individual stocks can help investors avoid these duds.

What happens if an ETF goes bust? ›

Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF. Receiving an ETF payout can be a taxable event.

Why are ETFs performing so poorly? ›

There are a few reasons why ETFs generally die. Low assets under management, high fees, poor performance, and short track records are closely associated with the probability of closure. In 2023, there were 244 ETF closures with an average age of 5.4 years and average assets under management of only $54 million.

Why am I losing money with 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.

Why would someone choose an ETF over a mutual fund? ›

ETFs usually have to disclose their holdings, so investors are rarely left in the dark about what they hold. This transparency can help you react to changes in holdings. Mutual funds typically disclose their holdings less frequently, making it more difficult for investors to gauge precisely what is in their portfolios.

What is the single biggest ETF risk? ›

The single biggest risk in ETFs is market risk.

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

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 it better to buy individual 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.

Can ETFs go to zero? ›

For most standard, unleveraged ETFs that track an index, the maximum you can theoretically lose is the amount you invested, driving your investment value to zero. However, it's rare for broad-market ETFs to go to zero unless the entire market or sector it tracks collapses entirely.

Why don't I invest in ETFs? ›

Commissions and Expenses

Every time you buy or sell a stock, you might pay a commission. This is also the case when it comes to buying and selling ETFs. Depending on how often you trade an ETF, trading fees can quickly add up and reduce your investment's performance.

Are ETFs more risky than stocks? ›

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

Why might someone choose to invest in an ETF rather than in stock? ›

ETFs can offer lower operating costs than traditional open-end funds, flexible trading, greater transparency, and better tax efficiency in taxable accounts. As with all investment choices there are elements to review when making an investment decision.

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.

References

Top Articles
Latest Posts
Article information

Author: Dr. Pierre Goyette

Last Updated:

Views: 6362

Rating: 5 / 5 (70 voted)

Reviews: 93% of readers found this page helpful

Author information

Name: Dr. Pierre Goyette

Birthday: 1998-01-29

Address: Apt. 611 3357 Yong Plain, West Audra, IL 70053

Phone: +5819954278378

Job: Construction Director

Hobby: Embroidery, Creative writing, Shopping, Driving, Stand-up comedy, Coffee roasting, Scrapbooking

Introduction: My name is Dr. Pierre Goyette, I am a enchanting, powerful, jolly, rich, graceful, colorful, zany person who loves writing and wants to share my knowledge and understanding with you.