STOCKS, ETFs & FUNDS: What's the difference?

STOCKS, ETFs & FUNDS: What's the difference?

What is actually the difference between stocks, ETFs and funds?

Madeleine Serlath

Mar 11, 2022

·

8

min read

Stocks, ETFs, funds & Co. - the range of securities is wide. But what is actually the difference between these three products? You are not alone in asking this question. Here you can find out how these securities differ from each other.

Speed Read:

But before we get started and look at the differences between stocks, ETFs & funds, I would like to briefly introduce beatvest to you. At beatvest, our mission is to make investing easier than ever before. As the most beginner-friendly investment platform, you can acquire knowledge about investing whenever you want and wherever you want. The selection of your investments is made as easy as possible in the app and the exchange with the community is always possible. If you also want to stay up to date, subscribe to our newsletter.

Now let's look at the differences between stocks, ETFs & funds.

What is a stock?

With a stock (also called: share), you buy a mini-part of a company and then you are actually a shareholder in that company. You will now think: Wait, what? I can then have a say and benefit from all the profits?

Well, you do benefit from the profits, but you can only have a say once a year when the annual general meeting takes place.

Companies go public to get equity capital - money they can work with as if it were their own. When you buy a share, you give equity to the company and become a shareholder. This means that you bear the full risk, but you also get a small piece of the company's profits - these are the dividends.

How high the price of a share is on the stock exchange is determined by the buyers and sellers on the market. The more people are interested in a certain stock and see future potential in the company, the higher the price will rise, i.e. the share price. If you are already invested, you are happy about rising prices, because that means the value of your share increases and you could theoretically sell it at a profit. Depending on what your strategy looks like.

With shares, the return, i.e. the profit, can be higher, but you also have a higher risk.

The risk with individual stock investments is very high. You are only betting on one horse and it has to perform. That means you should look at the company very closely. Different key figures in the company analysis give you information about how the company is performing. However, this does not necessarily mean that the share price will also develop positively because, as already mentioned, this is determined purely by the market - i.e. supply and demand. A share can go through the roof one day, or completely plummet the next.

To reduce this risk as much as possible, you can invest in funds or ETFs (exchange traded funds). They are still securities, but you can at least share the risk and thus ensure diversification (=risk spreading). Think of ETFs or funds as a big colorful basket of different financial products. There can be shares, bonds, etc. from different countries, different sectors, etc. in it. This means that you don't bet on just one company, as you would with a share, but on many different ones from many countries.

Now you might ask what’s the difference between an ETF and a fund?

Very roughly, an actively managed fund is, as the name suggests, managed by a fund manager. This means that it is precisely analyzed which companies are included in the fund or not. The ETF, on the other hand, is a passively traded stock market index that covers a specific market and invests automatically. Since no active management is necessary here, they are cheaper in many cases.

But now more precisely...

Exchange Traded Funds - a passive product covers an entire market

If you want to keep your risk as low as possible, you should invest in as many different companies as possible. ETFs make it very easy for you to do just that.

An ETF is an exchange-traded index fund. This means that we do not have active fund management here, where it is determined individually which shares are good or bad, but rather a so-called index is mapped. Although there is also an index committee and certain criteria as to which companies are included or rejected, there are no ongoing adjustments here.

Have you ever heard of the DAX? This is the leading index for the top 40 companies in Germany - it represents the German market. Of course, you could say that you buy one share of each company in the DAX and thus spread your risk, but that means a lot of unnecessary costs and work.

Instead, you can simply buy a DAX ETF. That means you invest in a single product (ETF) and automatically spread the risk over 40 different companies. Now you can't talk about broad risk diversification if you only invest in the German market. That's why you can do the same for the whole world. For example, the MSCI World Index would come into question; here you invest in almost 1,600 different companies with one ETF, so you spread your risk over 1,600 shares. Crazy, isn't it?

With ETFs, however, you can not only buy a basket full of shares, but also ETFs on real estate, crypto, commodities and bonds, for example. But then they are no longer called ETFs, but e.g. ETNs (Exchange Traded Notes) or ETCs (Exchange Traded Commodities).

The great advantage of ETFs, apart from the broad risk diversification, is the low costs. As already briefly mentioned, an index that already exists is simply reproduced here. No fund manager has to make active decisions, which is why online brokers can keep costs so low.

Actively managed funds - with careful selection

Active decisions play a much more important role in funds. With actively managed funds, it's still a big basket of different products, except that here someone actively chooses who is allowed in the basket and who is not. The risk is still very low because you are betting on many different securities, but the costs are now higher. That's because you're now paying someone to watch the market and you're hoping for the best possible return.

A fund collects money from investors and then invests it in a wide range of different financial instruments. Again, these can be shares, bonds, commodities, real estate, etc. Often, large teams are behind these decisions. Where it makes sense to accept the higher costs of an actively managed fund is in sustainable investing. Since ETFs are passive products, there is little sustainable impact. Often, the ETF does not always contain what one would expect from the name. With an actively managed fund, on the other hand, the companies are screened and must meet certain criteria. Here, for example, is a description of how cooler future selects its funds.

Shares, ETFs & funds - every financial product has its opportunities and risks

Basically, depending on which investment strategy you have chosen and how risk-averse you are, there are differences to consider. With individual shares you take a higher risk, but participate directly in the profits generated. If you want to save time analyzing individual stocks and prefer to spread your risk more, ETFs make sense. Here you can invest in many different securities with one product.

If you want to invest your money sustainably, then an actively managed fund makes sense, because here sometimes very large expert teams have an eye on whether it really is a sustainable investment. If, however, you say you don't want to deal with it at all, but simply want to track the market as cheaply as possible, then ETFs can be a good option.

Depending on which product you choose, it should always fit your personally selected investment strategy.

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