ETF vs stock: The difference between an ETF and stocks

Exchange-Traded Funds (ETFs) are a quickly expanding segment of the financial services market. The Canadian ETF industry has grown steadily over the years, and ETFs can be a useful asset to keep in your portfolio. [1]

Canadians interested in adding an ETF to their investments can screen, buy and sell ETFs all through online direct investing. Self-directed investing can be managed at a lower cost and on your own time.

Whenever you consider new types of investments, it helps to start by learning what they are and how they compare to your other options, including more familiar asset types, including stocks. Before you start investing in ETFs, it will help to know how they differ from investing in stocks.

What is the difference between an ETF and stock?

The difference between an ETF and stocks is that stocks are equity in a single company, whereas ETFs offer a collection of assets (which may include stocks) in a single investment. While an individual investor could purchase several stocks with the goal of diversifying their portfolio, ETFs are professionally managed and do the work of pooling assets for you.

Many ETFs are designed to track the performance of an index, industry or asset type, such as currency or bonds. ETF managers determine which assets they need to purchase and in which proportion to match the broad performance of that asset, industry or market.

Investors can buy and sell shares in an ETF the same as they would with any stock, but those shares represent a more diversified pool of assets. The fund’s assets are adjusted to match the appropriate benchmark.

A stock (or share) is equity in the underlying company. [2] When a company becomes publicly traded for the first time, it offers a number of shares of ownership to generate funds. In exchange, shareholders get a share of earnings and assets. Some stocks may generate dividends (taken out of the company’s earnings), while growth companies tend to reinvest their profits instead of paying dividends. [3] As the company’s value rises or falls, the value of the company’s stocks changes as well.

Diversification is an important element in your investment strategy. Diversification means taking advantage of the differences between asset types to distribute risks throughout your portfolio.

There are many ways investors can diversify their portfolios. They can invest in different types of assets, such as a combination of stocks and bonds. They can also create diversification within an asset class. For example, they can buy a number of different stocks.

The goal of many ETFs is to create diversification within an asset class to reproduce the returns of an entire index, industry or market.

Cost-conscious investors may be drawn to ETFs because they generally have lower fees than actively managed mutual funds. [5] When it comes to stocks, investors usually pay a commission to a stockbroker when they buy either ETFs or stocks, but owning stocks does not come with a management fee. [6] However, Scotia iTRADE now has a new commission-free ETF program that allows investors to reduce their costs even further.

If you are choosing between ETFs or stocks, control over your portfolio is also worth considering. There are many ways to invest, and some want more direct control over their portfolio than an ETF provides. ETFs can be attractive to investors who are not interested in doing too much of their own research or managing individual stocks, but this is not every investor’s preferred style.

ETFs are an easy way to gain exposure to a desired market or sector. [7] ETFs exist for a diverse array of stock markets, countries, currencies, industries and goals. Rather than pursuing a self-selected pool of stocks to gain exposure to a certain market, an ETF provides a professionally managed pool of assets with exposure to the desired market.

What are the similarities between ETFs and stocks?

While they represent different financial products, stocks and ETFs share much in common. Many ETFs are comprised of stocks themselves, though they may include other or additional assets.

ETFs can pool just about any type of asset, including bonds or commodities, but both stocks and ETFs are traded on stock exchanges around the world. You can purchase through a broker or direct online investment platform, and both can be traded at any time of day. They both offer high liquidity thanks to general high-volume trading, and investors can trade most of them at will.

Being listed on an exchange also means both have high price transparency. Stock exchanges provide real-time quotes and trading volumes, which provides a higher level of transparency than other assets.

ETF investors have two tax considerations to keep in mind: taxes paid by the fund itself and taxes paid by the investor when they sell the ETF. The fund must pay capital gains taxes on securities that are sold within the fund, and it must pay appropriate taxes on dividends, interest and foreign income. [8] ETFs tend to have lower turnover than mutual funds, as units can be traded on the stock exchange instead of redeemed for cash with the fund. [9]

The second consideration is capital gains taxes. Investors pay these in the tax year they sell an investment, including both ETFs and stocks. The capital gains tax is 50% of the profit made from the sale of an asset, minus deductions from capital losses. [10]

Dividends are payments in cash distributed to shareholders by publicly traded companies. Not all stocks pay dividends, as payments from a company’s earnings, and the company can choose to pay dividends or not. [11]

Some ETFs that own dividend-paying stocks may also distribute dividends, but as with stocks, not all funds are designed to generate income.

Advantages and disadvantages of an ETF vs stock

ETFs have both pros and cons compared to investing directly in stocks. The right fit will depend on your preferences, investing style and the composition of your existing portfolio. Before you choose between stocks and ETFs, it helps to know the advantages and disadvantages of the product.

Advantages of ETFs vs stocks

A single stock can be a high-risk investment, as it relies on the performance of a single company. Scotia Index Tracker ETFs aim to match the performance of an index, reflecting the performance of a wide range of companies. One poor-performing stock can potentially be set off by the performance of others.

Compared to stocks, the advantage is that ETFs have built-in diversification. The cost to achieve that diversification can also be lower, especially when it comes to high-cost stocks. ETFs provide an inherent mix. They’re also professionally managed and based on clear goals, with the research and analysis behind stock choices done for you.

ETFs can also offer exposure to more than just stocks. ETFs can include bonds, currencies, commodities and other assets.

Disadvantages of ETFs vs stocks

Some investors prefer having complete control over the assets they own. With direct online investing, investors are finding it even easier to choose the mix of stocks they want in their portfolios. If there is a particular company whose stocks you’re interested in, it can be better to go directly to the source.

In addition to the lower level of control, ETFs also come with management fees that you can avoid by owning stocks directly.

Choosing between an ETF vs a stock

Every investment choice comes with trade-offs. Investors often have to choose between higher potential returns and reducing the risk of major losses in their portfolios. The asset mix that investors choose determines the level of risk and the potential reward.

Why investors may choose ETFs

In addition to cases where investors choose ETFs to diversify their portfolios, some investors may also prefer an ETF if they want to invest in a high-risk industry. For example, in the technology industry, investing in an ETF reduces the risks that would come from one company’s failure to capture market space with a new product. If other companies have more success, one company’s poor results are mitigated.

ETFs can also be one of the easier and more affordable ways to invest in commodities or global currencies. They can be useful for investors looking beyond stocks who still want assets that are traded on stock exchanges.

Why investors may choose stocks

Investors choose to invest directly in stocks when they want complete control of their portfolio, or they believe that they can beat the market. Stocks might also appeal to investors who are interested in socially responsible or ESG investing, although they can also consider Scotia Responsible Investing ETFs. Investors who spend a lot of time researching their options and prefer to actively manage their own portfolios may prefer stocks.

Investing in both stocks and ETFs

Some investors may choose to invest in both stocks and ETFs. They can balance the advantages and disadvantages of both asset types. With Scotia iTRADE, you have the flexibility to see all of your options and find the right fit for your portfolio.