ETFs vs Stocks: What Are the Pros and Cons?

Whether you’re just getting started investing, or you’re an experienced investor looking for the next investment to add to your portfolio, an ETF vs stock comparison is wise. To get you started, we’ll begin with the basics, then take a closer look at the similarities and differences, as well as the pros and cons, of ETFs versus stocks. 

What Are Stocks? 

Also known as equities, stocks are investment securities that represent ownership in a corporation. So, when an investor buys shares of stock, they’re buying fractional ownership in a company, which will use the investor’s money as capital. As a stock owner, an investor can then share in any profits of the company. 

While investors can buy shares of privately held companies, stocks are most commonly purchased as shares of corporations that are publicly traded on exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq. To gain access to stocks, investors need an investment account for trading, such as a brokerage account, that can be opened with a broker or large financial institution. 

What Are ETFs? 

An exchange-traded fund, or ETF, is a pooled investment security that trades intraday on an exchange. This makes ETFs a hybrid of mutual funds and stocks. Like mutual funds, ETFs can invest in hundreds of individual investment assets, such as stocks or bonds, in one packaged security. But unlike mutual funds, ETFs trade during the day at any time the stock exchanges are open.  

Most ETFs passively track a benchmark index, such as the S&P 500, while some may track the price of a single asset or commodity, such as gold. A few ETFs are actively managed. Perhaps the greatest attribute of ETFs is their expense ratios, which are much lower on average than mutual funds.  

A secondary but important beneficial feature of an ETF is diversification, which comes from the ability to offer investors exposure to broad segments of the market in one investment security. 

ETF vs Stock: Similarities and Differences 

When comparing ETFs and stocks, there are multiple similarities and differences to consider. For example, ETFs and stocks are similar in that they both trade intraday on an exchange. However, an ETF can track the performance of an index of securities, whereas a stock represents ownership in just one corporation.  

How ETFs and Stocks Are Similar 

• Trading: ETFs and stocks both trade during the day, at any time the stock exchanges are open.  
• Prices and orders: ETFs or stocks both trade at market prices at the time of purchase, and investors can set limit orders or stop-loss orders on the trades. 

• Tax treatment: Gains for ETFs and stocks are taxed at short-term or long-term capital gains rates, depending on the holding period. Dividends and interest produced from ETFs also have similar taxation as stocks, which are either taxed as regular income or at the capital gains rate, depending on the type of income produced. 
• Minimum investment: Unlike mutual funds, neither ETFs nor stocks require a minimum initial investment to get started. Investors may be limited to the price of one share of an ETF or stock; however, some brokerages allow the purchase of fractional shares.  

How ETFs and Stocks Are Different 

• Structure: ETFs are pooled securities that track the performance of an index, which may represent dozens or hundreds of other securities, whereas stocks are single securities that represent ownership in one corporation. ETFs also have different legal structures that enable them to track the price of an asset or commodity, rather than an index. 
• Fees: While ETFs generally have low expenses compared to mutual funds, investors do not pay fees to hold a stock. 

• Diversified exposure: Most ETFs track the performance of an index that may include hundreds of securities, such as stocks, bonds or a combination of assets. Thus, ETFs may provide a diversified portfolio in one security, whereas a stock by itself is not diversified. 
• Risk: The diversified quality of a typical ETF often translates to more stable returns compared to an individual stock. 

Pros and Cons of ETFs vs Stocks 

When comparing ETFs and stocks, investors are wise to analyze the features and benefits of each, then use that information to weigh the pros and cons of investing in one versus the other. In the end, choosing between ETFs and stocks is a personal choice. 

Pros of Investing in an ETF vs Stock 

• Diversification: Rather than investing in just one stock, an ETF can provide exposure to hundreds of stocks or other assets in one packaged security. 
• Less volatility: An ETF that tracks the performance of an index of stocks will generally have less pronounced price movements up and down compared to an individual stock holding. Thus, an ETF will generally provide more stable returns than a stock. 
• Simplicity: Investors require little expertise to invest in ETFs, whereas stock investing requires a greater degree of knowledge, research, analysis and monitoring to manage properly. 
• Long-term outperformance: For periods of 10 years or longer, ETFs and index funds that track the performance of a broad market index, such as the S&P 500, have outperformed most actively managed portfolios that invest similarly.  

Cons of Investing in an ETF vs Stock 

• Lack of control: Stock investors can choose the stocks to hold in a portfolio, whereas ETF investors are not able to select the stocks held in an ETF. 
• Potential for underperformance: A single stock, or a small portfolio of stocks, can outperform a broad market index, such as the S&P 500. However, an ETF that tracks the performance of an index will never outperform its benchmark. 
• Fees: Although ETFs have low fees, and can trade commission-free, stocks don’t have expenses. 

Bottom Line 

ETFs and stocks share many similarities, including tax treatment and the ability to trade intraday on an exchange. However, there are significant differences, such as diversification with an ETF that investors can’t get from an individual stock or a small portfolio. Investors are wise to carefully consider their personal preferences and investing goals, as well as the pros and cons of ETFs versus stocks, before investing.