Stocks vs. ETFs, Which Side Do You Choose?
The Risk vs. Reward, and Tax Advantages
We talk a lot about ETFs vs. Mutual Funds, and we’ve even discussed ETFs vs. indexes, but how do exchange traded funds stand up against individual stocks? Let’s discuss in this battle of an ETF vs. Stock…
Ease of Transaction
Stocks are easy to buy or sell (with exceptions of course). You can call your broker, or sign into your online account and make the trade. ETFs are just as easy to buy. But unlike and index, it’s one transaction.
So as far as entering the stock market or ETF market, this one is a tie.
We know that the transaction costs of ETFs are lower than indexes and mutual funds, but when it comes to stocks, it’s a wash. Your commissions are based on each trade and with stocks and ETFs it’s per trade of the asset. So yet another tie.
It could go either way as there are some stocks and ETFs that are very liquid and others that are not. However, a general edge has to be given to stocks since there are more liquid stocks than ETFs. Advantage – stocks.
Risk / Reward
It can get tricky as any investment can have a different risk beta. However, you can make an argument that an ETF has slightly less risk since it’s a mini-portfolio and therefore slightly diversified, but it really depends on what is in the actual ETF. Then again, with less risk comes less chance of reward, so it all comes down to your risk tolerance.
We have to call this one a tie since it’s case-by-case for each investment.
Since both ETFs and stocks are single transactions, the capital gain taxes are realized when the fund or equity is sold. One of the tax advantages of ETFs is that it’s treated like a stock transaction on your tax return as opposed to mutual funds and indexes.
However, if you are an active trader of multiple stocks, one can make an argument that an ETF carrying those same stocks gives you a tax benefit. So for this battle, advantage - ETFs.
As an options trader, I am always looking at how I can use derivatives in my trading strategy, especially for hedging purposes. Now both ETFs and stocks list options, but there are more calls and puts on equities than ETFs, so on a sheer volume basis advantage – stocks.
Access to a Sector or Market
If you want to gain access to an industry, one stock purchase is probably not the best way to go. Buying multiple stocks is a more sound strategy. However, which stocks do you buy? How many? Should you just buy an index basket? Or you could by a pre-packaged asset that gives you instant access to a sector, say like an industry ETF. Advantage – ETF.
With bond funds and dividend ETFs, you can create revenue streams for your portfolio. Now you can make the same argument for dividend stocks, but not for bonds as they are a different asset. So ETFs get the 2-1 win in this case. Advantage - ETF
And the Winner Is…
So which asset is better? I think you know what I am going to say. It depends. Every investment choice you make should be made on a case-by-case basis.
However, as you can see, the whole point of ETFs is to give investors mini-portfolios that trade like stocks, so there are a lot of similarities between exchange traded funds and equities. More so than when you compare ETFs to indexes or mutual funds.
One last thing to note. The above comparisons are based on an individual stock vs. ETF. If you are considering a custom portfolio of stocks vs. an ETF, the whole game changes. Commissions are different, tax implications change, and almost every comparison is impacted. But, that is a discussion for a different day.