It i s important fora investor to understand the differences between individual stocks and exchange-traded funds (ETFs). Each one of it has its own advantages and disadvantages.
Diversification
Diversification is an attractive feature of ETFs. Instead of taking concentrated risks by purchasing individual stocks, investors can own an index of stocks with ETFs. Owning individual stocks has special risks and often requires diligent attention.
Leverage
Like individual stocks, ETFs can also be leveraged with margin. Margin is borrowing money from a broker to buy securities and involves considerable risk. Minimum maintenance requirements are enforced by the NASD (National Association of Securities Dealers), the NYSE and by individual brokerage firms. While margin investing can be profitable for investors correct about the direction of their holdings, the interest charges or borrowing costs can deteriorate returns.
Options
There is an multiplicity of option strategies with both stocks and ETFs. Purchasing call or put options is an aggressive technique. An options investor can control a large amount of ETF shares by paying a premium. The premium price is a fraction of what it would cost to purchase the shares in the open market. This provides an options investor with a great deal of leverage and a high risk/reward opportunity.
Shorting
ETFs, like individual stocks, can be shorted. Shorting involves selling borrowed shares which an investor does not own in expectation the price of an ETF will decline in value. If the ETF does decrease in value, it can be bought by the short seller at a lower price, which results in a profit. In 2007, the Securities Exchange Commission (SEC) decided to allow shorting individual stocks on a downtick. Shorting is an advanced technique and involves substantial risk.
Tax Loss Harvesting
Wash-sale rules don’t permit investors to realize a stock loss if they repurchase the same stock within 30 days. This problem can be avoided with smart tax loss planning. By redeploying the loss proceeds into an ETF in the same sector as the stock, for example, the wash-sale rule can be avoided. This allows investors to offset any capital gains with capital losses and still maintain market exposure.