Understand the Difference Between ETF and a Stock

The stock market allows the populace to become investors in publicly listed companies by investing in their shares. As these companies expand, their shares also increase in value. Most giant corporations and conglomerates globally have their shares listed on the stock exchanges. 

In India, there are more than 6000 publicly listed companies. The most common way to invest in the shares of a company is to purchase the company’s shares directly. However, an individual can start buying shares online after opening a Demat and a trading account. 

However, since there are so many listed companies, selecting a company’s stock is not an easy process. One can just not open their account and buy stocks of any company. Instead, they need to conduct a thorough analysis of the fundamentals of the business. They also must be up to date and well-informed of the macroeconomic trends. 

An ETF or exchange-traded fund, on the other hand, is an investment asset that operates similarly to a mutual fund. ETS, like mutual funds, constitutes a collection of stocks or bonds. However, unlike a mutual fund, an ETF can be directly bought or sold on the stock exchange using a trading app. 

An ETF may generally track an index or a sector. For example, in India, ETFs exist that track the Nifty or Sensex or sectors like banking and IT. There are 100 EFTs trading in the Indian stock market. You may be wondering now what is the ETF vs. stock meaning? What’s the difference between a stock and an ETF? So let’s have a brief discussion on it. 

What Should You Invest In?

Whether you invest in individual stocks or through an ETF, your main goal is to make a good return from the investment when the value appreciates. You can trade both stocks and ETFs anytime during a trading day. Both these assets are taxable as well. The significant factor between ETF vs. stock is that a professional manages the EFT. While you, on the other hand, manage your stock portfolio. The transaction fees of an ETF are also higher than that of stocks. But, to know what is best for you, you need to consider your risk appetite and your ability to research. 

Achieving Alpha

Achieving alpha simply means that the investment outperformed its benchmark in the stock market. In the Indian stock market, the Nifty 50 index is the most popular benchmark. Many investors opt for investing in individual stocks because they believe that investing in individual stocks can help them outperform the market. At the same time, they expect an ETF to deliver average returns in line with the market. However, there is also a high possibility of underperforming the market if one fails to pick the correct stocks. At the same time, an ETF can also decently outperform the market depending on its characteristics and composition.

When Stock Picking Might Work

However, one can outperform the market by a more significant margin if they invest in individual stocks, provided they do their research and pick the best stocks. For this, one needs to be competent to understand the underlying company’s business fundamentally. One should read its annual reports and financial statements and know how the company fairs against its peers. Apart from the individual stock, one should have a good understanding of the sector. 

One should identify which sector is going through headwinds and tailwinds. Headwinds are external factors that restrain the growth of a particular industry. At the same time, tailwinds lead to favorable circumstances that promote growth in the entire industry. One needs to keep up with the economic reforms, political reforms, demand-supply chains, and other macroeconomic trends. Only then can one create a thesis that will help them build conviction in the stock they plan to invest in. 

However, despite performing a thorough fundamental analysis of the company and the industry, the thesis of the investment may not play out, and one could go wrong. This scenario could lead to severe losses. Therefore, the company still needs to deliver appropriately to keep the thesis intact. 

Investors investing in individual stocks try identifying and picking out growth stocks. They pick out companies with high potential to grow exponentially in the future. They try to pick out companies that could become Reliance Industries or Bajaj Finance and deliver exponential returns. Nevertheless, most of these growth companies trade at very high valuations, and only a few are likely to prosper. 

ETF vs. Stock Difference

Here are the significant differences between ETFs and Stocks. 

Risks and Rewards

ETFs are less riskier investment assets when compared to stocks. Both are subject to volatility, but they are less volatile since ETFs track a more comprehensive index than stocks. Hence, one should stomach the high volatility period if one invests in individual stocks. Due to this, an ETF might only beat its underlying index by a small percentage. 

However, it can still beat the broader market by a high margin. It is possible, provided one invests in the right ETF. For instance, if one invested in an IT ETF tracking the Nifty IT Index, the EFT may align with the IT index but outperform the Nifty 50, the primary benchmark index. 

The profit from stocks depends entirely on the selection of stocks and a bit of luck. If one is successful at picking the right stocks, one can make very high returns. But if one fails to do so, they can incur heavy losses. One can still mitigate their risk even further if they can perform a fundamental technical analysis of the stock, even though technical analysis is not the highest priority in long-term investing. 

Knowing how to analyze price movements on the stock charts can help investors decide on a reasonable price level to invest in. It can also provide early warning and alert investors if the stock price will likely enter a long downwards trend. But, all said and done, investing in individual stocks still have very high-risk levels. 

Selection and Management Process

A fund manager manages an ETF. Conversely, one manages their stock portfolio. So the fund manager tries to keep the ETF on track with its underlying benchmark. At the same time, an investor investing in individual stocks aims for maximum return. For this, one needs to evaluate the stock and the industry holistically. The research to select the best stock is higher than that needed to select an ETF. When it comes to ETFs, one needs to know which index the ETF is tracking and its constituents. One should identify which sector has high growth potential and accordingly select an ETF.

Investment Opportunities

There are more than 6000 stocks to choose from in the Indian stock market. However, not every stock will give good returns. ETFs can invest in indices and sectors like the Nifty Next 50, IT, or banking. ETFs investing in foreign indices like the Nasdaq 100 have also become immensely popular. On the other hand, investing in foreign stocks may be more complicated. 

Conclusion

Investing in ETFs can be a passive type of investing. For example, one can simply start a SIP into an ETF that tracks the Nifty 50, and their portfolio will likely do as well as the index. Whereas, when investing individual stocks, they need to track the company, industry, and market actively. However, through diversification, one can mitigate their risk. 

One must also consider the liquidity of the financial asset. Liquidity refers to how easily the securities are convertible into a cash amount.  For stocks, the liquidity factor depends upon the company; if the company is well managed and a large-cap company, the stocks are high in terms of liquidity, whereas if it is a penny stock, then the conversion of stock in funds will not be convenient. In ETFs, these assets are the same as stocks. But the liquidity also depends upon the product that ETf carries in its group.  And the volume of the fund also affects the liquidity of the ETFs.

Frequently Asked Questions (FAQs)