The difference between Stock Bond ETF

The difference between Stock Bond ETF

You want to invest your money in the stock market but how do not know the difference between Stock Bond ETF? In this article you learn what these investment opportunities are and also the advantages and disadvantages of each category.

Following a brief summary:

  • If you want maximum control over your investments, than I would recommend investing direct in stocks. Also for long term investors will have the advantage that there are no annual fees to hold the stocks.

  • Use ETFs in efficient, rising stock markets like 2010 to 2016 in Germany, Europe or North America. Here, fund managers have a hard time adding value to low-cost, computer-driven ETFs.

  • Use bonds in less common niche markets, special indices and the bond market. Fund managers can certainly achieve performance advantages through clever stock selection and forward-looking investment strategies.

In the following sections, the individual opportunities to invest in equities (Stocks, Bonds, ETFs) are considered in detail.

Stock

With a stock you are buying a part of a single company like Apple for example. If the company does well, the stock price will rise and your investment will be worth more. The same is true the other way around. If the company is in trouble, your stock will also perform worse.

The buyer must pay fees for the purchase and sale of shares. These transaction costs are around 1% of the order volume, depending on the particular bank where the customer account is managed. However, there is a minimum fee, which must be paid for smaller purchases at least. This amounts is in most cases under $10.

In addition to the bank commissions, depending on the broker, fees may also be incurred for the stockbroker or the trading system or the stock exchange. However, these costs are often only relevant for foreign stock markets or derivatives trading.

The cheapest way to buy shares is direct trading. Numerous financial institutions offer their clients the opportunity to trade securities directly with them.

Advantage of stocks

  • A big advantage for long-term oriented investors who buy shares directly is that there are no ongoing costs or fees as long as the shares are not sold.

  • It is possible to operate so called stock picking. That is, investors analyze companies based on various criteria, such as the fundamentals of a company, and invest in companies that have a particularly good chance risk ratio. The goal is to outperform the market in the long run. The most successful and well-known investors of stock-picking are Warren Buffett or Benjamin Graham. You will find in our guide how you can analyze a company for stock picking.

Disadvantage of stocks

  • However, two things are needed for stock picking. On the one hand the knowledge to analyze the companies fundamental data and on the other hand it takes a lot of time to evaluate the individual companies in detail and to read business reports before investing in the company.

  • In general, it makes sense as an investor to spread the risk. That means investing in different sectors, regions and currencies. In order that the purchases by buying and selling not reduce the profit too much, it is advisable to have a minimum order size (for example, $2,000). If you want to invest in 20 companies in total, there must be $40,000 in cash. Especially at a younger age or when you start investing, there may not be enough capital available to invest in many individual stocks.

Bond

For a bond, the investor does not have to actively deal with the selection of investments. At a bond many people invest their money in a bond that can be thought of as a big pot. The respective bond managers invest the money from this pot in assets. These assets may e.g. stocks, bonds, derivatives, etc. The aim of the bond managers is to make the best possible investments by considering the respective risk through the investment. Information about the corresponding invested assets, the risk profile and the historical profit can be found in the respective prospectus.

In return for the paid-in capital, depending on the amount of their contribution, investors receive a certain number of investment certificates, each of which reflects the exact same proportion of the bond’s assets and identifies the investor as a co-owner. At the same time, they result in the holder’s entitlement to profit sharing in the development of investments and the right to redeem shares at the official redemption price.

The value of an investment will be calculated as the sum of all assets of the bond (including cash) divided by the number of shares. Inflows or outflows of investment funds into the fund assets thus have no influence on the value of a share.

The fact that the bond is managed by the bond managers, the investors pay an annual management fee. The fee is determined individually for each bond and is thereby directed to the invested assets. As a rule, the annual administration fee depends on the fund type:

  • Equity funds: 0.8% to 3 %

  • Pension funds: 0.5% to 1.3%

  • Open real estate funds: 0.5% to 2%

In addition to the management fee, many bonds charge an additional performance fee, which is typically between 5% and 25%. This should reward the special performance of the bond management. The additional fee is based on a specific absolute or relative target, such as outperforming a given benchmark or achieving a new high watermark. The out-performance variant is unfavorable to investors because if the bond only loses a little less than the benchmark in a bear market. The high watermark method safes the investor because it will only result in a performance fee if the fund has actually reached a new high.

Advantage of bonds

  • Managed bonds are able to gain more from a benchmark or index by skillfully managing their investments. To do this, fund managers reduce risk in difficult market phases through targeted investment decisions or increase the bonds’s return potential in boom phases by over-weighting promising papers.

Disadvantage of bonds

  • The composition of a bond is not entirely transparent, as a bond is actively managed by a bond manager. As there are mostly stocks from different indices and different asset classes in a portfolio, there is hardly to find a comparable benchmark. Anyone wishing to find out about the composition of the bond and its performance must study bond prospectuses.

  • Studies show again and again that few active bond managers manage to outperform their benchmark in the long term. Basically, they have a hard time making up for the cost disadvantage over ETFs through good investment results.

ETF

ETF stands for Exchange Traded Funds. These types of funds are not managed by bond managers, but are passive funds managed by computer programs. ETFs try to emulate a stock index, commodity index, real estate index or bond index. Therefore investors are able to invest in the gold or oil market the same as invest in a stock of the SP500. Just like traditional funds, ETFs are sold by banks or investment companies and traded at the stock market. Investors are able to buy and sell an ETF on every trading day at the stock market. Like stocks, ETFs are stored in your private portfolio.

Like a stock, an ETF has an ex-dividend date on which to pay the dividend. The timing of these dividend payments are on a different schedule than those of the underlying stocks and vary depending on the ETF.

There are two different types of ETFs in terms of dividends:

  • Dividends Paid in Cash: In this case dividends are paid out like the dividends of a share. It is up to the investor to use the dividend to buy new shares from the same ETF, to invest in other asset classes or to leave the disbursed dividend as cash on the clearing account.

  • Dividend Reinvestment Plans: The other option is that the dividend will not be paid out, but the dividend will automatically remain in the ETF, increasing the investor’s shares in the ETF. For the investor, there is the advantage that he does not have to remember to reinvest the dividend. Many providers only offer whole shares of the ETF. For example with a dividend of 10.2 shares in the ETF, 10 shares are automatically bought from the dividend and the remaining dividend is paid out to the investor.

Also there are two different types how the ETF emulates the underlying investment.

Physical Replica

In physical replication, the company that offers the ETF buys those stocks that are included in the corresponding index. For example, if the ETF depreciates the Dow Jones, then the company will buy stocks from Dow Jones companies to an appropriate extent.

However, if you want to invest in markets that either involve many companies (MSCI World) or companies that are not very liquid, physical replication would be very expensive. Thus, the buyer of the ETF would have to pay high transaction costs. For this reason, swap-based replication has been developed.

Swap-based Replica

The swap-based ETF has two actors, the ETF provider and usually the associated parent bank, between which the actual ETF and a supporting portfolio are exchanged. The customers, who buy the swap-based ETF, invest the money in the carrier portfolio. The ETF provider invests this money independently of the actual ETF. A contract is concluded between the ETF provider and the bank, which is not transacted via the stock exchange, but as OTC business (Over The Counter), an individually negotiated contract.

This agreement states that the bank receives the return on the carrier portfolio from the ETF provider. For this, the ETF provider gets the return of the index, which is reflected by the ETF. It does not matter if the returns are the same or different when swapping. The customer is assured that he will receive the return of the selected ETF. The ETF company thus has the advantage of being able to replicate even more complicated indices and obtain the return on equities that originate from niche markets and thus are very difficult to access or would be accessible only if high transaction fees were paid.

Advantage of ETFs

  • ETFs are cheaper than bonds. The ETF provider’s anual charge amounts between 0.1% to 0.5% because no bond manager is involved. Computer programs control the composition of the ETF with that of the fund and automatically correct the deviations.

  • Also the composition and performance of the ETS is very transparent, as the index is always displayed. If the index rises, then the ETF rises too.

Disadvantage of ETFs

  • The only read disadvantage of an ETF is that there is no possibility to outperform the market like an active managed bond.

Final Thoughts on the difference between Stock Bond ETF

There you go: You know the differences, the advantages and disadvantages for investing in stocks, bonds and ETFs.

Now I would like to hear from you..

What is your preferred method of investing in the stock market? Which funds or ETF do you already own or do you want to buy?

Either way, let me know by leaving a comment below right now.

Thanks for reading this article. Please, let us know if you have feedback, corrections, or any further question (either down below in the comments or via contact). We are happy to discuss and further support you along your way to becoming a “yield reviewer”.

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