Stocks, ETFs, and Mutual Funds: What are they?
Stocks, ETFs, and Mutual Funds: What are they?
The first thing you should do as an investor is to familiarize yourself with the investing jargon. Of course, at this point, you must have heard about stock, ETFs, and mutual funds.
So what are these three terms? Do they mean the same things?
Stock, ETFs, and Mutual funds are securities (trading instruments) you trade on the market. So, What are the differences between them? Which should you trade? Or can you trade them all?
Not to worry, you’ll get the answers to these questions in this article. In addition, you’ll get an overview of the terms, what they mean, draw comparisons, and some investment advice.
Stocks: An Overview
When you buy a company’s stock, you’re directly purchasing part of that company. With your stock, you become a shareholder/stockholder.
Stocks are also called equities and are valued based on the market price. If many people are buying the stocks of a particular company, the market price of that stock will increase. If too many people sell the same company stock simultaneously, the market price of that stock will decrease.
The type of stocks you invest in makes up your stock portfolio. You make money off the stock market in three ways. The most popular is stock trading. Stock trading is when you buy a stock at a lower price and sell when the price is higher. In simple terms, you buy low and sell high!
The second way is to trade indirectly through stocks options or stock indexes (Such as ETFs). And the third way to earn money is through dividends.
Dividends are your percentage of the company profits shared with stockholders. So, most companies pay you a certain amount at the end of a specific period based on your stock ownership agreement. However, not all companies pay dividends.
How can you invest with stock?
While there are other ways of investing in stocks, there are two popular ways to invest in the stock market. The first way is to buy stocks through a stock exchange such as the New York Stock Exchange (NYSE). Keep in mind that the actual purchase and selling from the exchange will be by your stockbroker.
The second way is to buy trade stocks via online platforms such as Robinhood. The online platforms act as the stockbrokers in this case. It is a more convenient way of trading. All you have to buy a company’s stock is tap on some buttons.
ETFs: An Overview
An Exchange Traded Fund (ETF) is an investment portfolio offered to investors as a single investment. It tracks the stocks of companies in a specific sector or industry. It is a good choice for people who want to invest in an industry but do not know which stock to buy.
Think of it this way; stocks are single security while ETFs are like baskets of several single securities.
For example, an ETF for stocks will focus on different company stocks. You can trade ETFs as a single investment. When you buy into an ETF, you are also buying the stocks that make up the ETF. That solves the problem of not knowing what company’s stock to buy.
On the other hand, you should know that you can’t choose the funds you want in your ETF. Also, you can’t decide to sell off individual stocks from your ETF.
When you invest in an ETF, the price you pay is calculated based on the market price of the stocks in the investment portfolio. ETFs trade like stocks; you can buy them at any time of the day.
There are three types of ETFs:
Exchange-Traded Open-End Index Mutual Fund,
Exchange-Traded Unit Investment Trust (UIT),
Exchange-Traded Grantor Trust.
Exchange-Traded Open-End Index Mutual Fund: Dividends from this fund are accrued and invested on the day of receipt. Shareholders receive the dividends in cash every quarter.
Exchange-Traded Unit Investment Trust (UIT): The stock portfolio in a UIT has specific investment limits, usually 25% or less. They do not reinvest dividends. Instead, shareholders receive the dividends in cash every quarter.
Exchange-Traded Grantor Trust: Holders of this kind of ETF have direct ownership in the companies in which the ETF is invested and have voting rights. They also receive their dividends directly.
Mutual Funds: An Overview
A Mutual Fund is an investment portfolio of different stocks and bonds offered as a single investment. They are similar to ETFs. However, if ETFs are baskets of securities, think of mutual funds as vehicles that pool money from several investors to buy collections of stocks and other securities.
When you invest in a Mutual Fund, the price you pay is based on the stock’s portfolio’s net asset value (NAV).
Fund managers typically manage Mutual Funds. These managers make the financial decisions and are paid commissions for their effort.
Also, you trade mutual funds differently. For example, unlike stocks, you can only buy them after the stock market trading hours.
There are two kinds of Mutual Funds:
Open-Ended Funds
Closed-Ended Funds
An open-ended fund doesn’t have a limit on the number of investors. That means the fund manager can keep creating shares of that fund and sell those new shares to investors. As a result, the price value of an individual’s share is not affected by the newly created shares. This type is the most popular kind of Mutual Fund.
Closed-ended funds have a specific number of shares. Fund managers can’t create new shares. So, The investor demand and not the net asset value (NAV) determines the price value. Mutual Funds of this kind are pretty rare.
Stocks vs. ETFs vs. Mutual Funds
Here, we will compare stocks, ETFs, and Mutual Funds under the subsequent headings. As you will notice, stocks and ETFs have a lot of similarities.
Type of Assets
Stocks are companies’ stocks that are purchased individually.
ETFs are an investment fund that tracks a particular market, especially an index.
Mutual Funds are investment portfolios that contain bonds, stocks, and other investment instruments.
Using the basket and vehicle analogy, you can think of stock, ETFs, and mutual funds in this simple way:
Stocks are single securities (this is the simplest form of trading instruments). And you can compare the ETFs to a basket of securities; it contains stocks of several companies from a particular industry. So ETFs are a bit more complicated/advanced trading instruments.
While you can compare mutual funds to investment vehicles, they pool money from different investors and buy several securities.
So, mutual funds can give ownership to several companies in different sectors. On the other hand, ETFs give you access to several companies in a particular sector/market. While stocks only allow you to own shares for that single company.
Type of Management
You can manage stock actively or passively
ETFs are mainly passive investments
Mutual Funds are primarily active investments
Trading Hours
You can trade stocks and ETFs throughout the trading hours. They open when the Forex market opens and close when it closes. On the other hand, you can only trade mutual funds at the end of trading hours.
Purchase Price
You buy both stocks and ETFs at market value. In contrast, you can only buy mutual funds at net asset value.
Market Returns
Your stocks’ return is based solely on their performance in the market. That applies to all the ways of making profits from the stock market.
You’ll get dividends only if the company makes profits at the end of a quarter. The same applies to stock trading; you can only sell when the market prices have increased unless you want to run into a loss.
ETFs make or lose gains based on the net asset value of all the stocks/securities in the fund. So, two or more company’s stock may be performing poorly, and you’d still be in profit. Mutual Funds calculate returns based on the net asset value of the overall fund.
Commissions and Fees
Stocks can be traded commission-free on some platforms. You don’t have to pay any fee after buying any company’s shares, regardless of what happens. ETFs are also commission-free, i.e., you don’t have to pay any fees after buying an ETF share.
On the other hand, Mutual Funds charge administration and marketing fees from investors after buying a share. Mutual fund managers overlook your portfolio and make investment decisions, so you pay them for their services.
Ownership
Stocks are actual ownership of a company’s shares; you own a part of the company. With the ETFs, you’re the owner of the securities in the investment basket. The Mutual Fund owns the securities in the basket, and then you owe a part of the Mutual fund.
Risks
When you invest in a stock, your risk is based on an individual company’s performance in the market. A bad performance or market crash, and you can lose all your capital.
Mutual Funds help diversify that risk by pooling stocks by different companies in a single investment basket. So, you’re not dependent on single security any longer. Similarly, ETFs reduce risks by tracking different companies’ shares in a sector or industry.
Stocks, ETFs, or Mutual Funds: Which Should You Go For?
The right option depends on your investment style, needs, and goals. There are several things to consider, so our advice will be based on many ifs.
If you are investing with a low budget, consider ETFs. You can invest in an ETF with as little as $50. In contrast, mutual funds have a higher minimum investment rate – some cost as high as $3,000. And the best-performing stocks usually cost hundreds of dollars.
On the other hand, if you want more control over your trade, go with stocks. Then, with some knowledge and experience, you can time the market and get great trades. Again, ETFs are the second-best in this regard.
Also, if you want active control of the stocks you invest in, stocks are the best trading instruments. However, if you don’t know which stock to buy, ETFs and Mutual Funds are your best bets.
Furthermore, if you’d like to invest passively with a diversified portfolio, ETFs and Mutual funds are the best options. With both, you get to invest in varieties of securities without any stress.
Lastly, if you want an experienced personnel to handle your investments, stick with Mutual Funds. Although you’ll have to pay commissions and fees, you’re sure the right person is in charge of your assets.
