If you’re new to investing, you’re probably overwhelmed by the thousands of investment options out there. And it can be frustrating trying to figure out what types of investments are suitable for you.
People also have different reasons for investing. Whether it’s investing some extra cash, planning for a long-term goal, or feeling like you need to get involved in the market, each investor’s reasoning is unique.
That’s why it’s important to understand the differences between two key investments: Individual stocks and exchange traded funds, or ETFs.
ETFs vs single stocks: What’s the difference?
A single stock is just that, a share of just one company. Examples of companies that you can buy stock in are Coca-Cola or Bank of America. These companies are publicly traded on a market exchange, meaning the general public can buy and sell their stock.
In contrast, an ETF is basically a basket of individual stocks wrapped up in one fund. ETFs give you the opportunity to invest in the performance of a group of stocks without having to buy every single stock in the fund.
ETFs trade on exchanges, just like individual stocks. That means wherever you can buy stocks you most likely can buy ETFs.
Note: ETFs can also include stocks, bonds, cash and other assets but for now, we’re just talking about stocks.
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It’s all about your portfolio
In order to figure out if stocks or ETFs are suitable for you, it’s important to understand the concept of creating a portfolio.
A portfolio is a fancy word for all of your investments, which may include stocks (also known as equities), bonds, ETFs and/or cash.
We believe that in order to create a well-balanced portfolio, you need to have a diversification strategy. This strategy will depend on the length of time you want to invest, and your future financial goals. Diversification doesn’t guarantee profit or protects you 100% from an overall market decline, but it does help distribute risk of your investments.
Diversification is an investing strategy. In short, it means not putting all your eggs in one basket. It helps investors distribute risk among different investments so if one performs poorly, losses aren’t as extreme as they would be if you only had one investment.
A poorly diversified portfolio is one where your money is invested in a single stock, or even a single industry. For instance, if all your money is invested in just one oil company, or even in a fund that consists of oil industry company stocks, you could lose big if the company goes bankrupt, or if the price of oil goes down.
In contrast, a well-diversified portfolio is one where your cash is invested in different stocks and investments in different industries. A more diversified portfolio may include some money invested in the oil sector, some in the healthcare sector, and additional funds in the tech sector.
A portfolio is usually built to match personal financial goals. Your goals and how much risk you want to take on to achieve them may depend on your age, along with your ability and willingness to take risk.
Source: Nerdwallet.com and Malkiel, Burton.
The previous infographic shows a very general picture of some of the portfolio mixes suggested by economist Burton Malkiel. Malkiel, a professor of economics at Princeton University, is famous for arguing that most investors can’t beat the market over the long run and that general investors are better of putting their money on diversified passive investments like index funds or ETFs.
Malkiel also suggests changing the mix of stocks, bonds, cash and real estate holdings as investors get older. Many investors choose to skew their portfolios to be more conservative as they get older. This usually means that investors desire more dependable returns and less risk as they get closer to retirement. Investors can achieve this by adding to their bond holdings over time, as bonds and bond ETFs are generally considered less risky investments than stocks or ETFs that only include stocks.
How a portfolio relates to stocks and ETFs
You can create a diversified portfolio with both ETFs and single stocks. But there may be significant cost differences. And investors should be concerned with pursuing the most cost effective way to implement an efficient portfolio. That’s because high costs can eat away the value of your portfolio.
You might think that one way to achieve a diversified portfolio is to simply buy as many different stocks across as many industries or asset classes as possible. However this strategy is time consuming and expensive, as major brokerage houses usually charge commissions every time you buy a stock, with prices ranging from $4.95 up to $19.95 per trade.
Some financial experts argue that you can achieve the benefits of diversification by buying between 18 and 30 stocks. But that could cost you up to $148 in total commissions with most major brokerage companies. That amount might not seem like much for an investor with a portfolio of $100,000, but for an investor with $1,000 or less to invest, buying single stocks could cost up to 15% of total investment savings.
ETFs can save you money
Before ETFs started to gain popularity in the mid-1990s, average investors tended to invest in mutual funds as a way to diversify portfolios and manage costs. However mutual funds started losing popularity due to high management fees and high minimum investments compared to ETFs. Mutual or index funds can have fees as low as .09%, ETFs can have fees as low as .03%. (Read ETF vs. Index Funds vs. Mutual Funds, What’s The Difference?)
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So who actually buys single stocks?
Picking individual stocks may be deemed a riskier investment strategy than picking ETFs because individual stocks aren’t a stand-alone investment that helps with diversification.
Investing in individual stocks is often best left to professional investors, professional traders or people who have enough time and financial knowledge to understand the market forces that can affect the stock price of a single company. Investors including individual money managers, hedge funds and investment banks have dedicated teams and resources to do the due diligence to assess whether a specific stock could have potential value for their clients’ portfolios.
Investment professionals who perform in-depth research on stocks can find hidden value that no one sees in order to profit in the long run of the success of the company.
Purchasing ETFs with Stash
In short: ETFs offer you more diversification than a single stock. With an ETF, you can have more exposure to different assets, including stocks, bonds and cash in one investment.
Companies like Stash offer a limited number of ETFs that have been curated by an in-house team of experts.
With Stash you can buy fractional shares of those ETFs, something not common with most old-school brokerages. This come in useful when a customer wants to start investing with small amounts of money. Fractional shares allow you to own a fraction of an ETF share.
Read the fund’s prospectus and summer prospectus (if available) before investing. It contains the fund’s investment objectives, risks, charges, expenses and other information, which should be considered carefully before investing. Obtain a prospectus and summary prospectus (if available) by contacting us at [email protected]
Exchange Traded Funds (ETFs) are subject to market risk, including the possible loss of principal. The value of the portfolio will fluctuate with the value of the underlying securities. ETFs trade like stock, and there could be brokerage commissions associated with buying and selling exchange traded funds unless trading occurs in a fee-based account. ETFs may trade for less than their net asset value.
This material should not be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. Any investments or strategies reference herein do not take into account the investment objectives, financial situation or particular needs of any specific person.