What Are Stocks and ETFs?
Stocks and exchange-traded funds (ETFs) are two widely used ways to gain exposure to financial markets. While both can be bought and sold through a broker and can rise or fall in value, they represent fundamentally different types of investments. A stock represents ownership in a particular company. An ETF, on the other hand, is a fund that typically holds a collection of assets and allows investors to gain exposure to multiple securities or a particular market, sector, commodity, or other asset through a single traded product. Understanding how stocks and ETFs work, how they differ, and what risks they carry is an important starting point for anyone looking to participate in financial markets.
What Is a Stock?
A stock, also commonly called a share, represents part ownership of a company. When a company issues shares, it is raising capital that can be used to support its operations, expansion, investment, or other business activities. When an investor buys shares, they become a shareholder and own a small portion of that company.
In Australia, many shares are traded through the Australian Securities Exchange (ASX), while investors can also access international companies through overseas markets such as the New York Stock Exchange (NYSE) and Nasdaq.
How Do Stocks Work?
The value of a stock is influenced by supply and demand, but the underlying company and broader market conditions can also have a significant effect on its price. Factors that may influence a company’s share price include:
- Company earnings and financial performance
- Revenue and growth expectations
- Industry conditions
- Economic conditions
- Interest rates
- Investor sentiment
- Company announcements
- Changes in management or business strategy
For example, suppose an investor purchases shares in a technology company. If the company reports stronger-than-expected earnings and investors become more optimistic about its future, demand for the shares may increase. This can push the share price higher. However, the opposite can also happen. Weak financial results, changing economic conditions, or negative company news can reduce investor confidence and cause the share price to fall.
What Are ETFs?
An exchange-traded fund, or ETF, is a type of managed investment product whose units can be bought and sold on an exchange. Unlike purchasing shares in one company, an investor buying an ETF generally gains exposure to a portfolio of underlying assets held by the fund. Depending on the ETF, those assets may include Australian or international shares, bonds, commodities, currencies, sectors, or other investments. Many ETFs are designed to track an index. For example, an ETF may seek to track the performance of a particular share-market index rather than attempting to select individual companies to outperform the broader market. There are also actively managed ETFs, where an investment manager makes decisions about the assets held by the fund.
How Do ETFs Work?
When you buy an ETF through a broker, you purchase units in the fund rather than directly owning each underlying investment. For example, consider a hypothetical ETF designed to track a broad share-market index. Instead of buying shares in every company individually, an investor could purchase units in the ETF and gain exposure to the collection of securities held by that fund.
The value of the ETF generally moves in response to changes in the value of its underlying assets. ETFs trade on exchanges during market hours, much like shares. Their market price can therefore change throughout the trading session.
Stocks vs ETFs: What Is the Difference?
The simplest distinction is ownership.
| Feature | Stocks | ETFs |
| What you buy | Shares in an individual company | Units in a fund |
| Underlying exposure | Usually one company | Often multiple assets |
| Diversification | Depends on how many stocks you own | Often built into the fund |
| Trading | Bought and sold through a broker | Bought and sold through a broker |
| Price movement | Influenced by the individual company and market | Influenced by underlying assets and market conditions |
| Management | You select and manage the shares | The ETF follows a stated investment strategy |
| Risk | Can be concentrated in one company | Depends on the ETF and its underlying holdings |
This does not mean ETFs are automatically safer than stocks. An ETF focused on one sector, commodity, country, or narrow group of assets can still carry substantial risk.
Why Do Investors Consider Stocks?
Individual stocks can provide direct exposure to a company’s performance. If a company grows successfully, its share price may increase, potentially providing a capital gain to shareholders. Some companies also pay dividends, although dividend payments are not guaranteed and depend on the company’s circumstances.
Owning shares can also provide certain shareholder rights. Depending on the type and structure of the shares, shareholders may have voting rights and other entitlements. However, investing in individual companies requires investors to consider company-specific risks. A single company’s poor performance can have a significant impact on the value of an investment concentrated in that company.
Why Do Investors Consider ETFs?
One of the main characteristics of ETFs is diversification. A single ETF can provide exposure to a basket of investments, potentially reducing reliance on the performance of one individual company. The degree of diversification depends entirely on the ETF’s underlying holdings and investment strategy. Other characteristics may include:
- Access to a broad market through one product
- Exposure to specific sectors or themes
- Access to international markets
- Exposure to bonds or commodities
- Trading flexibility during exchange hours
- Potentially lower costs than some traditional managed funds
Moneysmart notes that ETFs can provide diversification and that many ETFs have relatively low management expense ratios, although fees and other costs vary between products.
What Are the Risks of Stocks?
Stocks can provide opportunities for capital growth and income, but their prices can also decline. Some important risks include:
Market Risk: Broad market movements can affect stock prices even when an individual company is performing reasonably well.
Company-Specific Risk: A company can experience declining sales, increased costs, regulatory issues, management problems, or other challenges that affect its value.
Concentration Risk: Holding a small number of companies can leave a portfolio highly dependent on the performance of those individual businesses.
Volatility: Share prices can fluctuate significantly, particularly around major company announcements or periods of market uncertainty.
For this reason, investors should consider their investment timeframe, objectives, and tolerance for losses before deciding whether individual shares are appropriate for them.
What Are the Risks of ETFs?
ETFs also carry investment risks, and the specific risks depend on what the ETF holds. For example, an ETF tracking a broad share index will generally be exposed to movements across that market. A sector ETF may be more concentrated, while an international ETF can introduce currency-related risks. Potential ETF risks include:
- Market risk
- Sector or geographic concentration
- Currency risk
- Liquidity risk
- Tracking differences
- Management fees and other costs
- Risks associated with the underlying assets
Some ETFs use derivatives or other structures that can introduce additional risks. Investors should understand how an ETF works before trading or investing in it.
How Are Stocks and ETFs Bought and Sold?
Both stocks and ETFs can generally be traded through a broker. An investor typically opens a brokerage account, selects the relevant security or ETF, reviews the available trading information, and places an order. The price received can depend on the type of order used, market conditions, liquidity, and the price available when the order is executed.
For ETFs, investors should also understand the relationship between the ETF’s market price and the value of its underlying assets. Moneysmart recommends reviewing information such as the ETF’s net asset value (NAV), costs, underlying assets, and product disclosure statement before investing.
Stocks or ETFs: Which Is Better?
There is no universal answer. The more appropriate choice depends on an investor’s objectives, timeframe, risk tolerance, knowledge, and overall investment strategy. Someone researching individual companies may prefer direct exposure to selected stocks. Another investor may prefer an ETF because it provides exposure to a broader group of assets through one investment. The important point is not to assume that one product is automatically better or safer. Understanding what you are buying is more important than choosing an investment simply because it has performed well recently.
Common Mistakes to Avoid
Whether considering stocks or ETFs, several common mistakes can affect investment decisions.
Investing Without Understanding the Product: Before investing, understand what the asset is, how it generates potential returns, and what could cause its value to fall.
Focusing Only on Past Performance: Historical performance does not guarantee future results. Market conditions can change, and an investment that performed strongly in one period may perform differently in another.
Ignoring Costs: Brokerage, management fees, currency conversion costs, spreads, and other charges can affect overall investment outcomes.
Overlooking Diversification: Holding several investments does not automatically mean a portfolio is diversified. Multiple investments may still be exposed to the same sector, geography, or economic factors.
Reacting Emotionally to Market Movements: Short-term price movements can encourage impulsive decisions. A clear investment plan and appropriate risk management can help investors approach market volatility more deliberately.
What Should You Check Before Investing?
Before buying a stock or ETF, consider:
- What exactly does the investment provide exposure to?
- What are the main risks?
- What are the fees and costs?
- How liquid is the investment?
- What is your investment timeframe?
- How would a significant decline affect your financial position?
- Does the investment fit your overall strategy?
- Have you read the relevant product and company information?
For ETFs, the Product Disclosure Statement (PDS) can provide important information about the fund’s objectives, underlying assets, fees, transaction arrangements, and risks.
Key Takeaways
Stocks and ETFs can both provide access to financial markets, but they work differently. A stock represents ownership in an individual company, while an ETF provides exposure to a portfolio of underlying assets through a traded fund. Stocks can offer direct exposure to a particular company’s performance, while ETFs can provide diversification across a group of investments. Neither option is inherently risk-free, and the risks can vary significantly depending on the specific investment. For traders and investors, understanding the product, assessing the risks, reviewing the costs, and making decisions based on a clear strategy are important steps before entering the market.