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After you sock away an emergency fund in your online savings account, you might feel ready to try your hand at investing. To do so effectively, you need to know how to put your money to work using the stock market.
The two most popular ways to do that is by investing in either stocks or exchange-traded funds (ETFs). Depending on your investment goals, you can even do a little of both.
But before you dive into the fray, you need to know all about investing in ETFs versus stocks—and this guide is here to help. Here’s a look at what these terms mean and the top considerations to keep in mind as you create your investment strategy.
When you buy stocks, you are purchasing a percentage of the company and becoming a shareholder. As the company grows and thrives, the value of your shares increases, allowing you to profit from their successes. But when the company starts to struggle or even goes under, you can lose big on your investment.
You have the option to buy a single share in a company or thousands if you have the funds. The value of each share is based on the perceived and actual value of the company in question. You can hold on to the stocks for the long term or quickly sell your shares if you decide it’s not a good investment or want to go in a different direction.
Exchange-traded funds are a collection of investments, including:
When you buy ETFs, you gain a percentage of all the investments in that collection. The investments may come from a single industry or a whole index, like the S&P 500.
In recent years, specialist funds have gained a strong following because of their tendency to follow key trends. If much of the world focuses on embracing green technology, for example, sustainable energy ETFs could get a major boost.
With basic and specialist ETFs, since your funds are spread out across multiple entities, you are not as susceptible to losses if a single stock, commodity or currency in the collection suddenly tanks. Your ability to rake in massive profits when a particular entity takes off is muted as well.
Both ETFs and stocks are sold on the major stock exchange indexes, like the NASDAQ and NYSE. While building your portfolio, you can focus on either one or both, depending on your overall investment goals.
While deciding whether you should start investing in ETFs vs stocks, there are some things to consider, such as:
Since ETFs contain many products in a single basket, they are generally much less risky to own and trade than individual stocks. If any of the investments in the ETF lose a lot of value, the others will protect your funds from falling too fast.
Stocks can lose virtually all of their value overnight if the company is not doing well or is simply perceived as going under. The stock market can prove fickle which is why you must diversify as much as possible.
ETFs are naturally diversified by the entity that put together the collection. While you do not have to think about spreading your money out across companies, you also do not control over how it’s done.
With stocks, seek out companies that give you a good mix of low to medium risk investments. That way, you have a better chance at seeing your investments trending upward rather than crashing down because of overly leveraging high-risk stocks.
Since ETFs contain so many investments, any spikes in individual values do not translate to big wins for you. Instead, you’ll likely see a slow and steady increase in the value of your holdings, which is plenty of reward enough for most.
If you want to hold on to investments with a bigger potential for major gains, then stocks are likely the way to go. With individual stocks, you get the full value of the increase in your pockets, as a reward for weathering the higher risk.
Liquidity refers to how quickly and easily you can buy and sell your stocks and ETFs. With stocks, liquidity depends on the overall standing of the company.
If you buy shares in a stable, financially sound company, you will probably find it’s easy to trade their stocks as needed. If you go with a lesser-known company, like ones with shares worth less than a penny, then you could wait weeks to liquidate your shares.
ETFs are similar in that the liquidity of the stock depends on the quality of its collection of investments. If the ETF is full of poor-quality stocks or has a low trading volume, then its overall liquidity may not meet your expectations.
Stocks and ETFs both give you plenty of ways to realize profits through the life of your investment. You can trade away your stocks and ETFs, of course, as the value rises, though cutting out early could result in missed opportunities.
Or with certain holdings, you can collect dividends regularly, which are a cut of the profits made by the company each quarter. Some companies even use their funds to buy bonds and then split the gains from those investments with their shareholders.
If you do collect dividends on your ETFs or stocks, you will need to pay taxes since it’s considered income. And when you sell stock or ETFs for a profit, you must pay capital gains tax as well. You can work with a tax professional to deduct your initial investment and losses to offset the taxes owed each year.
To choose between investing in ETFs vs stocks, assess your personal risk tolerance and overall investment goals. Although stocks are unlikely to help you get rich quick, they do have the potential for bigger gains if you can avoid the downswings. ETFs are often a safer way to invest, but that’s no guarantee it will pay off in the end. If you aren’t sure which option to choose, you can always work with a broker who can offer guidance and help create your ideal investment strategy.