ETFs vs. Stocks: What Is The Difference?

It is not always easy to know what to invest in and what is the most suitable for your situation. Investing via ETFs and investing via direct stocks each have advantages and disadvantages. The article below aims to help you choose between these two alternatives. 

But, more fundamentally, you may wonder whether you should not also invest in some high-potential stocks. Is it better to invest in ETFs rather than directly in stocks? Shouldn’t you do both? You are right to ask yourself these questions before launching your first stock market orders. Below you will find some elements for reflection and comparison. 

Simplicity 

The number of “lines” in a portfolio corresponds to the number of investments you make at a given time. Generally, the more “lines” there are, the more complicated it is to follow. Your ETF portfolio could consist of a single line (e.g., World ETF) or only a few lines (e.g., 3 ETFs for Europe, the USA, and emerging countries). 

On the other hand, a stock portfolio requires more lines. A usual recommendation is to have between 8 and 25 lines in your stock portfolio. You could consider fewer lines. After all, 2/3 of Warren Buffet’s investment portfolio in September 2020 was only five companies (Apple, Bank of America, Coca-Cola, American Express, and Kraft Heinz). But you may not have Warren Buffet’s flair, although I hope you do. And a poorly diversified portfolio is highly exposed to the few companies it does have in its portfolio. 

So, an ETF portfolio may contain fewer lines. It’s often easier to track. And you’ll spend less time managing your portfolio. Another argument in favor of ETFs is related to the relative simplicity of their selection. Choosing an ETF is relatively easy. You “bet” on Europe, the USA, or another region. Or even on particular sectors or more specific criteria (“value” vs. “growth,” “low-carbon economy, “…).  

Then you select the best ETFs, mainly based on their assets under management and their fees. And to aim for better performance, some approaches try to optimize this ETF selection over time. And this is the Easy Trend portfolio approach. 

Investing in stocks is usually more complex. You could choose and do what is called stock-picking among the 40 companies of the CAC40. But you could also consider more than 600 other stocks on the Paris stock exchange that might have a more significant potential (because analysts follow less). Most of these companies are PEA eligible. Not to mention the other European marketplaces in which you can invest via a PEA. So, in the end, you would have to choose among hundreds, even thousands of potential companies. 

Diversification 

As you know, you shouldn’t put all your eggs in one basket. In the stock market, it’s the same thing. And as mentioned above, a good practice is to build up a basket of at least eight stocks. You can invest indirectly in hundreds or even thousands of companies with a portfolio of one or a few ETFs.  

An MSCI World ETF invests directly or indirectly in more than 1500 companies. In addition, an ETF portfolio facilitates sectoral and geographic diversification (Europe, USA, Asia, and Latin America…). But how could you diversify in this way with a stock portfolio? It is impossible for us as individual investors. 

For portfolios of a few thousand euros, diversifying even partially via a stock portfolio can also be complicated in practice because of the prices of the stocks in question. For example, if you want to invest 1000 euros in a stock portfolio and include the LVMH stock. You will not be able to diversify sufficiently because the LVMH stock is listed at more than 500 euros (in February 2021). A single LVMH stock in your portfolio will weigh more than 50% of your portfolio! 

Also, note that you cannot diversify your PEA outside Europe with a stock portfolio. Because these stocks are not eligible for the PEA, it is impossible to invest directly in American, Chinese, or other stocks. On the other hand, you can invest in ETFs that indirectly replicate the performance of these non-European stocks. Very interesting from a global diversification point of view. 

One may object that with a portfolio of 2 or 3 ETFs, you are not diversifying compared to ETF issuers such as Amundi, Lyxor, and Blackrock… And this is true. However, these companies are among the leaders in Europe, and this risk could be considered secondary. 

Costs 

Let’s now compare the costs of the two types of portfolios. In terms of annual management fees, the stock portfolio has an advantage. This one has no management fees. In contrast, an ETF portfolio will incur management fees of 0.2% per year if you select ETFs with limited fees. When it comes to transaction fees, it all depends on how you manage your portfolio. Generally, stock investors are more active than ETF investors and make more transactions. 

For example, let’s say you are a stock investor. In one year, you make an additional turnover of your entire portfolio compared to the ETF portfolio. This simple surplus of transactions could cost you 0.2% of additional annual fees (0.1% on sale + 0.1% on purchase, considering a fairly optimized transaction fee of 0.1%).  

And this will offset the benefit of no management fees. Of course, if you make more trades in a year or your broker is not very competitive, it will cost you more or even more. I’m not even going to talk about traders who make daily trades. When it comes to trading, there are two other things to consider: 

Generally, the lower the transaction amounts, the higher the percentage of transaction fees. However, individual stock portfolio transactions have a smaller amount, as the portfolio is divided by 10, 20, or more. And this can work to the disadvantage of a stock portfolio, especially if it is only a few thousand euros. 

When you buy a stock, the buy order is positioned in the order book, where there is a spread between the first buy orders and the first sell orders. And this is the spread, which can be 0.1% or much more for small stocks. This spread is often more critical on individual stocks than on ETFs with large amounts outstanding. And this effect can further affect the performance of a stock portfolio. In practice, and without going into too many technical considerations, it is not always so easy to position oneself in the order book against this spread.