Individual Stocks vs. Exchange-Traded Funds
A quick comparison of similarities and differences between the two
It's important for investors to understand the key differences between individual stocks and exchange-traded funds (ETFs). Each has its advantages and disadvantages. This knowledge can translate into making intelligent investment decisions. Let's focus on the key points.
Diversification
Diversification is an attractive feature of ETFs. Instead of taking concentrated risks by purchasing individual stocks, investors can own an index of stocks with ETFs. Owning individual stocks has special risks and often requires diligent attention.
In addition to reducing market volatility, many investors have cut their commitment to time consuming and expensive stock research. By over and underweighting ETF industry sectors, for example, investors can obtain an optimal allocation that suits their financial goals.
Leverage
Like individual stocks, ETFs can be leveraged with margin. Margin is borrowing money from a broker to buy securities and involves considerable risk. Minimum maintenance requirements are enforced by the NASD (National Association of Securities Dealers), the NYSE and by individual brokerage firms. While margin investing can be profitable for investors correct about the direction of their holdings, the interest charges or borrowing costs can deteriorate returns.
Options
There are a multiplicity of option strategies with both stocks and ETFs. Purchasing call or put options is an aggressive technique. An options investor can control a large amount of ETF shares by paying a premium. The premium price is a fraction of what it would cost to purchase the shares in the open market. This provides an options investor with a great deal of leverage and a high risk/reward opportunity.
A more defensive approach uses put options in conjunction with portfolio holdings. Buying protective puts on ETF or stock positions would insure a portfolio against declining prices. There are many other tactical possibilities with options.
Shorting
ETFs, like individual stocks, can be shorted. Shorting involves selling borrowed shares an investor does not own in expectation the price of an ETF will decline in value. If the ETF does decrease in value, it can be bought by the short seller at a lower price, which results in a profit. In 2007, the Securities Exchange Commission (SEC) decided to allow shorting individual stocks on a downtick. Shorting is an advanced technique and involves substantial risk.
Tax Loss Harvesting
Wash-sale rules don't permit investors to realize a stock loss if they repurchase the same stock within 30 days. This problem can be avoided with smart tax loss planning. By redeploying the loss proceeds into an ETF in the same sector as the stock, for example, the wash-sale rule can be avoided. This allows investors to offset any capital gains with capital losses and still maintain market exposure.
(1) For employer sponsored retirement plans, stocks of other companies and ETFs may not be available as an investment option. Self-directed retirement plans may offer a broader menu of investment choices which may include stocks and ETFs.
| Individual Stocks vs. ETFs | Individual Stocks | Exchange Traded Funds |
| Continuous trading and pricing throughout the day? | Yes | Yes |
| Can be bought on margin? | Yes | Yes |
| Can buy/sell options? | Yes | Yes |
| Can be shorted on a downtick? | Yes | Yes |
| Can be purchased through a traditional or online broker? | Yes | Yes |
| Can use in an IRA, 401(k), or another retirement plan? | Yes(1) | Yes(1) |
| Traded on what exchanges | Amex, NYSE, NASDAQ | Amex, NYSE, NASDAQ |
Brokerage Products and Services offered by Scottrade, Inc. - Member FINRA and SIPC
Any specific securities, or types of securities, used as examples are for demonstration purposes only. No information on this Web site should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security.
Investors should consider the investment objectives, risks, charges, and expenses of an ETF carefully before investing. For a prospectus containing this, and other important information, contact the fund company. The prospectus should be read carefully before investing.
Investors should consider the investment objectives, risks, and charges and expenses of a mutual fund carefully before investing. A mutual fund's prospectus contains this and other information about the mutual fund. Prospectuses are available through our trading site or through a Scottrade branch office. The prospectus should be read carefully before investing. No transaction fee (NTF) funds are subject to the terms and conditions of the NTF funds program. Scottrade is compensated by the funds participating in the NTF program through recordkeeping, shareholder, or SEC 12b-1 fees.
Investors should consider the investment objectives, risks, charges, and expenses of an Exchange-Traded Fund (ETF) carefully before investing. A prospectus contains this and other information about the ETF can be obtained from the issuer. The prospectus should be read carefully before investing.
Margin trading involves interest charges and risks, including the potential to lose more than deposited, or the need to deposit additional collateral in a falling market. Margin Disclosure Statement (PDF) is available for download, or it is available at one of our branch offices. It contains information on our lending policies, interest charges, and the risks associated with margin accounts.
Options are not appropriate for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (also available at one of our branch offices). All option accounts require prior approval by Scottrade.
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