Okay so you’re eager to take a shot at investing your money and you’ve short-listed two instruments - Stocks and ETF. But you’re unsure about the right instrument to select? Well, these two are great options to choose from since both options are equity-oriented investments that are considered high-risk, high reward to some extent. Before delving into the details, let’s first have a refresher on what these instruments are just to be sure.

Stocks refer to the shares a company issues once it goes public. The funds raised from these stocks are used to finance the venture. In exchange, each shareholder gets a portion of the company’s ownership. Based on the type of stocks held, investors can get certain privileges like participating in company decisions and getting dividends.

ETFs, or exchange-traded funds, on the other hand, are a basket of stocks, commodities and bonds managed by a fund manager. Investors can buy units of such a fund and invest in a more well-rounded portfolio and gain exposure to various types of financial instruments. 

How are Stocks and ETFs different?

Here are some of the key differences between stocks and ETFs: 

What are the risks of investing in stocks and ETFs?

All investment involves some level of risk. A prudent investor is one who can build a portfolio that shrewdly offsets high-risk financial instruments against low-risk ones, also aligning the rewards offered by each. And to offset the risks, first, you need to know what the risks are.

Stocks

Market risk: 

The prices of stocks are governed by the highs and lows of the stock market, which fluctuate all the time. The rule of thumb for investing in stocks is to buy at a low price and sell at a high price to make a profit. 

Liquidity risk:

 Stocks are considered highly liquid assets since you can always sell and convert them into liquid cash. But there can be situations when particular stocks cannot be sold, causing liquidity risk.

Company risk: 

The business and performance of a company directly affect the price of a stock. Analysing a company’s financials before investing is crucial.

Macroeconomic risks: 

Changes in external factors such as taxability, interest rates, regulation and inflation can have an impact on the price of a stock.

ETFs

Market risk: 

The underlying asset in an ETF consists of stocks, so the fluctuations of the stock market have an impact on the price of the ETF unit held by an investor.

Complexity: 

ETFs incorporate a range of investment instruments, giving investors more exposure. However, the more complex the fund, the harder it is to track the performance of these diverse investments.

Tax risks:

 The tax implications of ETFs can be hard to understand because they all have different structures. For example, an ETF that consists of commodities and derivatives may also have complex tax implications.

Which one is better for me?

In short, it all depends on your financial goals, the amount you want to invest and your risk appetite. But here’s a framework to think about the situation.

When stocks are better:

• When you’re keen on outperforming the market. If you’re looking for an option that can give better returns than the index, then you can consider stocks.
• You’re comfortable deep diving into the analysis of each company. If you have the time, energy and commitment to follow a particular stock or industry, analyse financial statements and keep a tab on the current affairs regularly.
• You have prior experience and in-depth knowledge of the market. This is a straightforward indication that stocks are the preferred investment choice.

When ETFs are better:

• You’re new to investing. This is a great choice if you want to start getting up to speed on the market yet don’t want to miss out on investing.
• You don’t want to spend much time investing. If you have other commitments and are looking for a convenient solution to investing then ETFs are a good choice.
• You want to invest in a variety of assets and not fixate on one. ETFs are a perfect instrument as you get exposure to a variety of stocks that help reduce risk.

Summing up

The question isn’t whether an ETF is better than stocks because both investment options have their own pros and cons. The question, instead, should be this – which one is right for you, and when. While ETFs expose investors to various types of markets, stocks are comparatively restrictive. However, gauging the performance of ETFs is more complex than stocks.

FAQs

1) Should I invest in an ETF if I’m planning to buy a house?

If you are planning to buy a house, you need to set aside some money for your downpayment and plan subsequent EMIs. The safest way to save this money is to put it in a savings account. However, money parked in an ETF is also a good option as it attracts higher returns and is less risky than directly investing in stocks.

2) Should I invest in stocks in my 20s?

People in their 20s can make the most out of investing a sum of money in stocks because they can stay invested for a long time and reap the benefits later. This will work provided you do your adequate research before choosing which stocks to invest. 

3) Are ETFs a good investment for your retirement account?

While your entire retirement fund shouldn’t comprise of ETFs, they do make a great tool for portfolio diversification. They can passively expose an investor to several indices, sectors as well as investment products. They are also a relatively less risky investment option than directly investing in stocks.

4) Should I invest in stocks with an education loan?

It is generally considered better to pay off all pending debts before making any risky investments. However, with efficient financial management and by smartly allocating funds, one can set aside money for their EMIs as well as investments.