Exchange-Traded Funds- ETF, a better investment choice than Stocks?
Exchange-Traded Funds or commonly referred to as an ETF are a collection of market-traded securities. These securities can be Stocks, Bonds, and Commodities or a combination of all of these. Large financial corporations like Vanguard, Blackrock Inc., and Invesco Ltd. are well-known issuers of ETFs.
ETFs comprise marketable securities and are traded on stock markets just like individual stocks. The ETFs prices also work on demand-supply and overall fund performance, similar to the Stock pricing.
How is an ETF Categorized?
As ETFs are a combination of marketable securities, the simplest way of categorizing ETFs is based on security types. ETFs can be divided into Stocks, Bonds, and commodity ETF types.
An Exchange-Traded Fund consisting of diversified stocks. The portfolio of these stocks can be from the same industry or different sectors. The aim is to create a diversified collection of stocks to mitigate the risk and increase returns.
Just like Stock ETFs, these funds consist of Bonds. Bond ETFs also pay regular coupon payments and are traded like individual bonds. Bonds are securities issued by Federal Governments and large companies to borrow large capital from markets.
These are ETFs selected with stocks from companies in a particular sector. Although it also hedges the risk with diversification but often moves at the same direction in price as the industry stocks or index moves.
Other types of ETFs may include Commodity ETFs comprising of commodity securities like Gold or oil. Foreign Currency or Internationally traded stocks ETFs are also commonly traded.
How ETFs are Different from Stocks?
From an investor’s perspective, the risk-reward principle remains the same for any kind of investment. The main difference between investing in an individual stock and ETF remains the diversification. With an individual stock, you put all the money on a single firm’s performance, whereas in an ETF you are betting against a portfolio of underlying stocks or securities.
Investing in ETFs over individual Stocks:
You may think, you can diversify the risk by buying more than one individual stock. Fair enough, what about the costs associated with buying individual stocks? How to choose the right type of stock to invest in with the right timing?
Large corporations running financial markets issue ETFs. They pool ETFs the best way to mitigate the risks and outperform the industry i.e. index or mutual funds.
When does it make sense to invest in individual stocks?
Trading with individual stocks through brokers with quick reward trading strategies like Scalping or Shorting is risky. Higher risks bring higher rewards (and losses). The costs associated with stock trading are higher than with ETFs.
If you’ve extensive knowledge of stock trading and investing, and you seek to maximize quick gains, Stock trading is for you. You’ll have to go through fundamental and technical analyses round before investing or hire a broker who could act on your behalf.
When does it make sense to invest in ETFs?
Investors usually look for long-term gains with investments in ETFs. Although ETFs are also traded all day long, and go through price swings like individual stocks, they remain stable overall.
If you’re looking for long-term capital gains, ETFs investments are for you. However, ETFs also offer certain advantages and limitations like any other trading asset.
Advantages of Investing in ETFs:
As ETFs pool several securities in a single bucket, diversification remains the highlighted feature of investing in an ETF. ETFs also offer some valuable advantages over investing in individuals stocks and mutual funds.
- ETFs come with lower overall costs as compared to individual stocks or mutual funds.
- Exchange-Traded Funds can be bought or sold like individual stocks and considered liquid investments
- Diversification of securities make ETFs low-risk investment with low costs associated
- ETFs come with the option of dividend reinvestment, thus increasing returns on a compound basis
- ETFs are more tax advantageous than individual stocks and Mutual Funds
- Investors can choose between Stock-based portfolios or industry-based portfolio
Exchange-traded Funds offer investors a blend of options for quick profits through short selling or long-term capital gains. Investors can also make a regular income with dividends and coupons with selected ETFs. Thus, ETFs offer far more flexible and risk-averse investment options than investing or trading with individual Stocks.
Risk of Investing in ETFs:
Exchange-Traded Funds also carry certain risks as of any other marketable security.
- Despite pooling different securities in a single ETF, it might carry the industry risk. A swing in a particular industry will eventually affect all sector ETFs and Stock ETFs
- Investors may have to incur larger tax payments as compared to Mutual Funds, as ETFs are traded frequently and capital gains are distributed among shareholders
- ETFs are frequently traded, more than Mutual Funds, but still carry the liquidity risk higher than individual Stocks
- Investors looking for regular income may not find high-dividend or coupon benefits with ETFs as compared with Blue Chip Stocks