ETF vs. stocks: Are ETFs better than stocks?
Updated: August 23, 2024
If you’re new to investing or looking to improve your portfolio, you may wonder about ETF vs. stock investments. ETFs and stocks play important roles for many investors, and deciding which is best for you depends on your investment goals and knowledge. Holding only ETFs, or a mix of stocks and ETFs, is the best choice for many people.
When deciding if ETFs are better than stocks, it’s important to understand how stocks and ETFs work, ETFs unique risks and costs and how they may fit into your long-term investment strategy. Here’s a closer look at ETF vs. stock investing to help you make more educated investment decisions.
Stocks explained
Stocks are a method of buying and selling shares of companies. When you buy a share of stock, you’re buying a small fraction of ownership. Companies often have millions or billions of shares, and ownership is spread among many thousands or even millions of investors.
For example, tech company Apple Inc. has 15.2 billion shares¹ outstanding, consumer staples company Procter & Gamble lists 2.3 billion shares and Warren Buffet’s conglomerate Berkshire Hathaway has just 1.44 million A shares² outstanding.
Stock share prices tend to increase when the company grows in profitability, and some stocks make payments to shareholders in the form of dividends. If a company performs poorly, the price will likely decrease. Owning a diverse portfolio of stocks helps manage the risk of a single stock having an outsized influence over your total investment returns.
Why invest in stocks?
Single stocks offer direct investment in a company, which can be beneficial if an investor believes it will provide outsized returns. If you strongly believe a company is on track for above-average growth and profits, you may give it a spot in your portfolio. If you invest in a group of about 10 to 20 stocks and one leads to 10x growth, it could be a major boon for your finances.
Stock market risks to watch out for
When investing in single stocks, building a diversified portfolio is much harder. If you own only five stocks and one has a particularly bad year, it could lead to a negative result for your entire portfolio. It can be difficult to predict how a company will perform, and there’s always a risk of a bad quarterly result that leads to a huge drop in the share price.
Best for expert investors
While investing in single stocks can be exciting, and anyone would love to hit it big in the stock market, it’s difficult for investors to beat the market by buying single stocks. As we look at the section on ETFs, even professional investors rarely beat the markets in the long term. Unless you’re an expert investor with significant assets, you may be best off sticking with ETFs over stock picking.
Where to buy stocks and ETFs
If you’re an active investor or options trader looking for a way to save money on trades, you may want to check out discount broker tastytrade. The online service has some of the lowest prices around.
Acorns is an investing service and savings tool rolled into one. This microsavings app makes investing almost painless because you're spending only pennies at a time.
Interactive Brokers offers low trading fees and robust trading tools — major assets to day traders and other DIY investors. Lower-volume traders will also appreciate that they can access commission-free trading through the IBKR Lite plan.
ETFs explained
Exchange-traded funds (ETFs) allow investors to invest in multiple stocks, bonds or other assets with a single purchase. With one transaction, you can add hundreds or thousands of different investment assets to your portfolio, offering instant diversification and exposure to a segment of investments or even the entire stock market at once.
For example, an S&P 500 ETF allows investors to buy shares of all 500 companies in the S&P 500 index without having to buy each stock individually. A total stock market ETF gives you thousands of stocks. You can also choose ETFs focused on specific types of stocks or areas of the economy.
Most ETFs require an annual management fee, which can range from fee-free³ to more than 10% per year⁴. When picking ETFs, paying close attention to fees, underlying assets and past performance compared to market benchmarks.
Why invest in ETFs?
While investing in single stocks can be difficult and risky, investing in ETFs offers a passive and lower-risk method to maximize returns. According to data from S&P Global⁵, more than 87% of actively managed funds performed worse than the S&P 500 index over the last 15 years. While past performance is no guarantee of the future, there’s a strong trend that investing in a low-fee index fund is better than single stocks.
ETF market risks to watch out for
While investing in ETF index funds tends to be better than investing in single stocks, it still comes with some underlying risks. In poor economic conditions, the entire market can drop, giving investors a painful period of losses. Every market segment and index carries unique risks, so knowing what you’re buying is critical.
Also, beware of high fees. While low-fee index funds charge around 0.10% or less per year, actively managed funds and niche funds often charge much more, potentially taking a large chunk of your investment gains over time.
Best for typical investors
When more than 80% of professionally managed funds can’t consistently beat the stock market, why should we think we can? Wall Street pros often spend 60 hours per week analyzing stocks using the latest high-tech tools and methods, and they usually don’t do better than indices like the S&P 500. Buying low-fee, market-tracking ETFs is the best choice for typical investors.
ETF vs. stock investing
Stocks and ETFs have a lot in common. In fact, many ETFs are made up of stocks. You can buy and sell stocks and ETFs through the same brokerage accounts on the same stock exchanges. Here’s a look at similarities and differences when comparing ETF vs. stock investments.
| Features | ETF | Stock |
|---|---|---|
| Near-instant online trades | Yes | Yes |
| Low commission trades | Yes, often commission free | Yes, often commission free |
| Diversification | Can include thousands of companies | Just one company |
| Fees | Management fees typically apply | No management fees |
| Dividends | Passed through from stocks | Depends on the stock |
When are ETFs better than stocks?
For most investors, ETFs are better than stocks for long-term investments and when the investor doesn’t have the time or skills to analyze single stocks. ETFs give investors instant diversification and faster trading times than similarly composed mutual funds.
ETFs that follow market indices also tend to outperform actively managed funds and many individual investors. Historically, the S&P 500 returns around 10% per year over a long period, making it a good bet for retirement funds and other long-term goals.
Depending on your unique financial situation, you may find a combination of ETFs help align your investments with your financial strategy.
Pros and cons of ETFs
For most investors, ETFs are arguably better than stocks, but it's not perfect. Here’s a look at the pros and cons of ETFs that every investor should consider.
Pros
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Instant diversification
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Fast buying and selling times
-
Often commission-free trades
Cons
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Management fees typically apply
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Susceptible to poor market conditions
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Many actively managed funds underperform market indices
When are stocks better than ETFs?
For many users, picking single stocks is a losing game. But there are times when buying stocks makes sense. If you’re looking to actively manage a smaller subset of your portfolio not intended for critical needs like retirement or paying for a child’s education, single stocks can earn a spot in your investment accounts.
According to the investment strategy of The Motley Fool⁶, a popular stock-picking newsletter service, if you buy a group of 25 or more stocks and most perform roughly at the market average and one or two perform poorly, but just a few stocks perform exceptionally well, you can still outperform the market.
Every stock is unique. Just because you like one product or executive at a company doesn’t mean it will perform well over time. Understanding the potential for each stock to earn growing profits and fend off competition is vital in building a successful portfolio of single stocks.
Pros and cons of stocks
While we lean toward ETFs for most investors, stocks have unique pros and cons to consider. Those focus on having more control over a portfolio, but also the potential for more risk.
Pros
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Granular control over investment
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Typically commission-free trades
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Build a portfolio around a specific theme or strategy
Cons
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More risk with single stocks
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Higher potential of one bad pick causing outsized losses
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Can be difficult to analyze and track many stocks
How can stock-picking services help?
Stock-picking services can be a valuable resource for investors who want to make informed decisions in the stock market but don’t know where to start. These services offer expert analysis, research and recommendations that help users identify potentially profitable stocks. By relying on professional research and insights, investors can save time and minimize the risks involved with picking stocks.
In addition to providing recommendations, stock-picking services often offer curated lists of stocks tailored to different investment strategies. For example, services like The Motley Fool or Moby base their picks on in-depth research and market trends around specific types of companies. These curated lists can simplify the investment process for those looking to diversify their portfolios.
While no stock-picking service can guarantee success, it can be a useful tool in developing a more informed investment strategy. However, be aware that some stock-picking services have tens of thousands or millions of customers and can move the markets based on its advice. As with other investment decisions, it’s wise to proceed with caution when following the advice of a stock-picking service.
Our picks for stock picking services
If you invest in single stocks, it's not always easy to pick the next winner in the stock market. The Motley Fool is a well-respected stock picking service with a nearly 30-year track record.
Moby, also known as Moby Invest, uses real expert analysis to provide investment recommendations. Founded to democratize access to high-quality investment advice, Moby offers a variety of features to help users make better choices.
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Eric Rosenberg is a finance, travel and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full time.
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