ETFs vs. Shares: A Guide to Similarities and Differences
While exchange traded funds (ETFs) and individual shares have plenty of common characteristics, there are important differences between the two investment vehicles.
Learning more about how ETFs and shares compare can help you tailor your portfolio to your investment goals.
What is an ETF?
An exchange traded fund (ETF) is a basket of individual securities that can be bought and sold in a single trade on a stock exchange. The individual securities within an ETF can be shares, bonds, currencies, commodities, or other investments.
When you buy shares of an ETF, you own a fraction of the underlying pool of investments, much like you do when buying shares of a managed fund. The net asset value (NAV) of an ETF represents the per-share value of the fund’s assets less any liabilities.
ETFs have grown exponentially since 1993 when State Street Global Advisors launched the first US-listed ETF. Today, investors can choose from thousands of ETFs to meet their individual portfolio needs, from gaining broad market exposure and generating income to accessing difficult-to-reach markets.
What is a Share?
A share is a security that represents part ownership of the specific issuing company. Publicly traded shares trade on exchanges, like the Australian Securities Exchange (ASX).
ETF vs. Shares: Similarities
Transparency
The holdings of most ETFs are fully transparent and available daily. This means investors know what they own at any moment, allowing them to make informed investment decisions with greater accuracy. Similarly, when investors hold individual shares, they know what they own.
Broad Range of Investment Options
Both ETFs and shares can be used to gain exposure to a variety of market segments, covering different geographic locations, market capitalisations, styles, sectors, and industries.
Transaction Fee or Commission
Because ETFs and individual shares are bought and sold on an exchange, they are both generally subject to a brokerage fee. Note that some online brokers offer commission-free trading of shares and ETFs.
Pricing and Trading
Investors can buy and sell ETF shares and individual shares on an exchange continuously throughout the trading day. Because shares and ETFs trade throughout the day on an exchange, they offer favorable liquidity and allow investors to make timely investment decisions and quickly execute based on shifting market conditions.
Exchange trading also means the trading prices of both ETFs and shares represent the current market price. With an ETF, the unit price may be slightly more or less than the net asset value (NAV).
Exchange trading also means investors can employ a wide range of trading techniques — from buying on margin to placing limit orders.
Dividends
Many companies periodically pay out a portion of their profits to shareholders in the form of dividends. Similarly, ETFs may receive dividends from companies they hold, which are in turn paid to investors who own shares of the ETF.
ETFs vs. Shares: Differences
Diversification
Passive, or index, ETFs generally track a benchmark index. They provide access to many companies or investments in one trade, whereas individual shares provide exposure to a single firm. As such, ETFs remove single-stock risk, or the risk inherent in being exposed to just one company.
The diversification of index funds across many securities can dilute the potential negative impact of poor performance of any one security.
Research and Management
ETFs are professionally managed funds backed by a team of experts working to meet the goals outlined in the fund’s product disclosure statement. Fund managers are tasked with buying and selling individual holdings in return for a fee.
Expense Ratio
ETFs have an expense ratio, which includes management fees and the fund’s total annual operating expenses.
Capital Gains Distributions
Turnover in an ETF’s holdings — due, for example, to changes in an ETF’s underlying index — could trigger the sale of securities. This may trigger transaction costs and capital gains distributions. In this scenario, any realised gains or losses are passed on to ETF unit holders. To ensure tax efficiency, ETF managers attempt to limit these types of transactions as much as possible. ETFs’ tax-efficient in-kind redemption process used to meet shareholder redemptions limits capital gains distributions.
Shares vs. ETFs: Similarities and Differences
| ETFs | Individual Shares | |
| Transparency | Fund holdings generally made available each day | Investors know what they own |
| Range of Asset Classes | Offer exposure to a variety of market segments | Offer exposure to a variety of market segments |
| Brokerage Fee or Commission | Generally subject to a brokerage fee | Generally subject to a brokerage fee |
| Pricing and Trading | Exchange traded; investors can buy and sell shares continuously throughout the trading day at market prices | Exchange traded; investors can buy and sell shares continuously throughout the trading day at market prices |
| Dividends | Yes, where applicable | Yes, where applicable |
| Diversification | High; provide access to many companies or investments in one single trade | Low; provide exposure to a single firm |
| Research and Management | Professionally managed | Investors handle research and trading on their own |
| Expense Ratio | Yes | No |
Are ETFs or Shares Right for You?
When choosing whether to add individual shares or ETFs to a portfolio, it’s important to consider your risk tolerance and overall investment objectives. In many instances, ETFs provide a solid foundation for a diversified investing strategy, offering an easy way to gain exposure to a breadth of asset classes, sectors, and regions.
For their part, individual shares allow investors to express specific bets on companies, but lack of diversification may increase overall portfolio risk. Ultimately, the optimal portfolio may contain a blend of shares, ETFs, and other investment products.