Stocks and exchange traded funds are popular investments with individual and institutional investors. Stocks represent ownership of a company, and the percentage of ownership depends on how many shares you own. An ETF is similar to a mutual fund except that it trades throughout the day like a stock. The decision to buy ETFs vs. stocks depends on an investor’s risk tolerance, investing goals and available capital. Knowing how the two investments compare and contrast can help you determine which one is best for your investment portfolio.
Liquidity is the ability to quickly convert an asset to cash. In theory, stocks are perceived as more liquid than ETFs. When determining liquidity for a stock, an investor must consider the trading volume of only one company. In contrast, the liquidity of an ETF depends on the trading volume of each underlying asset within the fund. That said, there are stocks that are not very liquid and ETFs that are extremely liquid.
Investors pay tax on stock when a capital gain is realized and when they receive dividend income. As of 2012, dividends are taxed up to 15 percent depending on your tax bracket. You pay a 5 percent tax on capital gains if you are in the 15 percent or lower tax bracket and a 15 percent tax if you are in the 25 percent or higher tax bracket. The taxation of an ETF depends on its underlying assets. According to an article on CharlesSchwab.com, stock and bond ETFs receive the same tax treatment as regular stocks and bonds. ETFs invested in precious metals are taxed at a 28 percent tax rate. The tax rate for commodity and currency ETFs vary, depending on the asset structure of the ETF.
The cost associated with investing in stocks is typically related to the brokerage fees you must pay to buy or sell shares. Two common costs associated with an ETF include trading costs and operating expenses. The trading cost of ETFs is the same as for stocks, which vary by brokerage firm. Some discount brokerage firms charge per transaction while other firms charge a flat fee. The operating expenses associated with an ETF are charged to pay for administrative cost, portfolio management and other costs. In most cases, the costs to trade ETFs are more than the costs to trade stocks.
One of the most attractive features of an ETF is diversification. An ETF includes a variety of assets placed in a single investment vehicle. For example, an investor can own an ETF that includes a variety of stocks from companies in emerging markets. The diversification of an ETF allows you to spread the risk associated with the investment. In contrast, you must invest in several stocks to achieve the diversification of an ETF. Although this is possible, it makes managing your portfolio more complex.