When choosing investments you will often hear about the need to diversify. This is the fancy way of saying, “Don’t put all of your eggs in one basket.”
Choosing a number of different stocks across various industries is one way to diversify. Of course, for the average retail investor, that’s a little more time and effort than they wish to put into their investment plan. This is where exchange-traded funds (ETFs) come in.
Stocks vs ETFs: The Basics
On the surface, stocks and ETFs can seem very similar. They both trade on the market and their prices can change throughout the day as traders buy and sell. This means that both stocks and ETFs have volatility. However, that’s about where the similarities end.
A stock tracks a single company. News about this company like earnings reports, CEO changes, new products launches, and more can influence the price of a stock. One bad rumor or breaking news story can destroy the value of a stock.
ETFs, on the other hand, have a much wider view. Exchange traded funds track entire indexes, commodities, and groups of assets. This much wider view means that a single ETF could have dozens or hundreds of individual stocks within its holdings. Essentially, ETFs have diversity built right in which is one of the reasons why ETFs have become so popular over the last decade.
So, Stocks are More Volatile?
A stock tracks a single company, one piece of news could shake investor confidence in a company and cause the price of the stock to plummet. One piece of good news could send the stock price rocketing to the moon. For holders of this individual stock, that could be one wild ride. In the grand scheme of things, that news may not have a major impact on the markets at all.
An ETF will track the entire performance of a sector, index, commodity, or group of assets. One stock going up or down in price within the focus of the ETF will have a minor impact on the price of the ETF because it is just a small piece of a larger puzzle.
So, ETFs are the Safer Choice?
Again, it’s impossible to answer a black and white question with an honest answer. In general, the diversity of an ETF will make it less volatile than an individual stock. With that said, choosing an ETF that tracks a volatile market and comparing it with a consistent, well-performing stock may show that the individual stock is less volatile.
Each ETF and individual stock needs to be considered on a case by case basis. Don’t jump up to paint all investments with the same brush.
Looking to start investing in ETFs?
ETFs may offer you more diversification than a single stock, however its important to keep in mind they are subject to volatility like many other investments. With an ETF, you can have more exposure to different assets, including stocks, bonds and cash in one investment.
Companies like Stash offer a curated selection of ETFs and some individual stocks. You can download the Stash app for free, learn about investing and create a diversified portfolio of ETFs with as little as $5. Sign-up and claim a $5 credit to start investing here.