If you are looking to invest your money in the stock market, you might be curious about ETFs. But are ETFs safer than stocks? To find the best and safest avenue for your investment, you need to first understand what ETFs have to offer and what the risks are.
An ETF or Exchange Traded Fund is generally safer than stocks because each ETF is well diversified. ETFs are often a steady way to grow your cash and are more liquid than a mutual fund. Purchasing ETFs is therefore often less risky than purchasing stocks. However, some ETFs focus on high risk industries and research is therefore advisable before investing.
Before pulling the trigger on your investments, make sure you know the risks. Below is a summary of what ETFs have to offer.
Exchange Traded Funds
Are ETFs safer than stocks?
Well, before fully understanding the answer to this, we need to define ETF’s.
An Exchange Traded Fund, otherwise known as an ETF, is a type of investment that trades for a fluctuating exchange value of different stocks and commodities on the market. This can be difficult to understand if you aren’t familiar with how the stock market works, so let us break it down for you.
Each exchange traded fund is watched over by a broker or group of brokers that are constantly on the lookout for promising trades. For example, brokers watch the value of commodities like gold or diamonds because they fluctuate slightly throughout the week and during the day.
Other valuable things like stocks, bonds, and currencies vary in value even more from day to day and from hour to hour.
The ETF brokers buy and sell rights to these stocks and commodities constantly during the day. They expertly trade consistently valuable things. They avoid major losses by diversifying the trades they make and by only buying or selling at numbers that are very close to the object’s market value.
Investors buy shares in an ETF to give the organization money to trade with. Shareholders then indirectly own the stocks and goods that the ETF purchases, so they are entitled to a portion of the profits.
Shares in an ETF can be divided and organized in many different ways, but they all follow the same basic principles of buying and selling.
Why Are They Called ETF’s?
The reason that these funds are called “exchange traded funds” is because of the way that different assets are sold.
Instead of buying a stock or commodity and then selling it for a price of their choosing, ETFs sell their assets “on exchange”. “Trading on exchange” means that instead of buying and selling something for a quoted price, things like gold are sold for exactly what their value is on the market.
For example, if you had a gold ring you could either sell it for a price of your choosing at a yard sale, to a friend… or you could sell it for exactly what the gold ring is said to be worth in the gold market.
What’s The Advantage Of Using Exchange Value?
The advantage of trading on exchange value is that you can sell things almost instantly. The disadvantage is that you can’t negotiate a price or set your own.
ETFs take advantage of trading on exchange to buy and sell things many times each day.
Compared to mutual funds, which only buy and sell things according to their value at the end of the day, ETFs buy and sell on fluctuating exchange values during the day. This brings with it many advantages and disadvantages compared to stocks and mutual funds, but ETFs are generally considered safe options for investment.
This is covered in much more detail in our Beginners Guide To Index Funds.
ETFs Compared to Stocks
Tradings stocks is a simple way to invest (made even simpler with a robo advisor).
Shares in a company can be bought or sold as you choose, in order to make a profit as the company’s value goes up (or as it goes down).
One of the biggest advantages of trading stocks is that you have a high amount of control and agency over what you buy. You can also buy directly instead of needing to work through a middleman.
Because you can invest a lot of money into one company, stocks are a way to multiply your investment quickly if the company that you invest in increases in value quickly.
Wise trading and good investments can pay off in both the long run and the short run. Unfortunately, there are many downsides to trading stocks.
The Downside To Trading Stocks
The biggest downside in trading stocks is the risk. If the company that you invested in begins to lose value due to changes in the market or having too much competition, your stock portfolio could quickly lose its value.
Thankfully, the stock market generally goes up in value, which means you typically earn rather than lose money. However absolutely nothing is guaranteed!
Another problem with trading stocks is that there are many taxes associated with buying, selling, and owning stocks.
What About ETFs?
ETFs, on the other hand, avoid the worst of these two problems. An exchange trading fund can easily diversify what they buy and sell, covering the stock value that is lost by having several stocks and commodities that gain value.
Diversification is the first rule of stock trading, and ETFs take that into account. Furthermore, the rapid trading strategies employed by ETFs mean that losses are easily avoided.
Another bonus of ETFs is that the income you gain from these funds isn’t heavily taxed.
However, there are some fees associated with owning an ETF – most of which fall under the umbrella of broker fees. However, these fees are generally lower than the ones charged by mutual funds.
So Are ETFs Safer Than Stocks?
All in all, an ETF is something of a middle ground between mutual funds and stocks.
Stocks take the end of the spectrum with the most potential income but have the most potential for losses.
Mutual funds take the other end of the spectrum with losses being uncommon, but growth stays low.
Exchange Transfer Funds are a combination of both, offering lower risks than stocks but a higher potential for income than mutual funds.
Remember though, not all ETF’s are created equal. Some invest in intentionally risky sectors as volatility can bring rewards. These particular ETFs may be more risky than stocks. You may therefore wish to avoid them.
All in all, good investors see ETFs as solid funds to invest in, especially if you are trying to widen your portfolio and explore new sources of income through the stock market.
Wherever you choose to invest your money, be sure to investigate your options and understand the tax requirements for each.
A good place to start is:
