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When planning to invest in markets, investors often find themselves in a dilemma of choosing whether to invest in stocks directly, or through Exchange Traded Funds (ETFs). Some investors may find direct stock investments interesting and exciting since there is more control over investment decisions, and they can track the stock prices over stock exchanges.
However, at the same time, other investors may find stock investing complicated, as different macroeconomic events may impact the stocks differently. Therefore, unless investors can fully understand the nuances of stock investing, they may find it simpler to invest through mutual funds or ETFs.
ETFs are passive investment options which offer direct investment exposure to underlying indices like NSE Nifty50, S&P BSE Sensex, etc. or commodities like silver, gold etc. These funds invest at least 95% of their assets in replicating the underlying indices. This article discusses the difference between stocks and ETFs and aims to help the question: are ETFs better than stocks?
Here are the investment considerations one must consider while deciding to invest in stocks vs ETFs:
Diversification
When one invests in stocks, the investment risk is concentrated on a particular company. Therefore, any adverse impact on the growth of that specific company can severely impact the investment returns. This also goes against the investment advice of not keeping all one's eggs in the same basket. However, one can maintain a diversified portfolio of different stocks to counter such investment risk.
In contrast, investing in specific ETFs may allow portfolio diversification within a single investment product. This is because ETFs track an underlying index, which is itself a basket of equity securities. As such, ETFs may simplify the diversification strategies for investors.
Research
When investing in stocks, one needs to research the company and its growth potential. Further, one needs to stay updated about the corporate developments to review the decision to stay invested or exit from the company, which requires both time and effort.
In contrast, ETF investing may be relatively easy, as the only effort involved from the investor is regarding investing and selling ETF units depending upon the financial goals and the investment portfolio is tracked by a professional fund management team.
Control over investment decisions
When one invests in stocks, they ultimately control their investment decisions. As such, the stock selection is entirely the investor's choice. In contrast, ETFs are passive investment products wherein there is no discretion for the investor or the fund manager to choose the portfolio securities.
Investors do not control the investment decisions in an ETF. However, one can stay assured that the investment decisions will align with the underlying index composition changes.
Suitability for retail investors
Stock investing may be challenging and require awareness of the company's fundamentals. It may also necessitate staying updated with regular events impacting the company. As such, direct stock investing may not be advised for all newbie retail investors. In contrast, ETFs track underlying indices constructed using scientific and back-tested techniques.
Retail investors may find it relatively straightforward to invest in ETFs and have direct investment exposure toward broader market indices.
Transaction costs
When investing in stocks or ETFs, some transaction costs are involved in the trade while buying or selling units. However, ETFs are also charged with scheme expenses, including fund management charges (albeit at a relatively lower scale), transaction costs, selling and distribution costs, etc. However, some investors may find that the benefits of ETF investing outweigh such scheme expenses.
Taxation of gains from stocks and ETF units
The gains earned by the investors from the sale of equity shares and ETF units are both taxed as Capital Gains under Income Tax Laws. There is no difference in the tax treatment as far as equity shares and equity ETFs are concerned. The summary of the tax rates applicable is given below:
| Holding Period | Capital Gain | Tax Rate |
| Less than 12 months | Short-Term Capital Gain (STCG) | 15% |
| 12 months or more | Long-Term Capital Gain (LTCG) | 10% after an exemption of Rs. 1 lakh for LTCG from equity shares and equity funds in aggregate in a financial year |
Note: The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2022 presented in the Parliament in February 2022. The tax rates for capital gains are exclusive of the applicable cess and surcharge, and such tax rates will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment. Please contact your tax advisor for professional tax advice.
Disclaimer:
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
To know about the KYC documentary requirements and procedure for change of address, phone number, bank details, etc. please visit https://www.utimf.com/servicerequest/kyc. Please deal with only registered Mutual funds, details of which can be verified on the SEBI website under "Intermediaries/market Infrastructure Institutions". All complaints regarding UTI Mutual Fund can be directed towards service@uti.co.in and/or visit www.scores.gov.in (SEBI SCORES portal). This material is part of Investor Education and awareness initiative of UTI Mutual Fund.
