Futures vs Stocks: Key Differences

Futures and stocks are two of the major classes of financial assets available to retail investors. Each are capable of offering returns on your investments, but for different reasons. Both have significant risks, but futures are generally considered riskier than stocks. Many investors tend to invest primarily in one or the other. They are either stock investors or futures hedgers or speculators. Regarding futures vs. stock, we take a look at the risks and rewards of both to shed light on the debate.

If you’re deciding whether to trade futures, consider working with a financial advisor, one who understands not just futures but also your goals, risk profile and timeline.

Investing in Stocks

Investing in individual stocks allows you to own a small piece of a company, giving you direct exposure to its potential growth and profitability. When you purchase shares, whether a few or several hundred, you’re essentially becoming a partial owner of that business. Stocks can be an essential component of a well-rounded investment portfolio, especially for investors focused on long-term capital appreciation.

Building a Diversified Portfolio

A common misconception is that you need dozens of stocks to build a diversified portfolio. In reality, diversification can be achieved with as few as 9 to 13 well-selected stocks across different sectors and industries. However, this requires knowledge, time and discipline to research and choose stocks that are likely to perform well over time.

Warren Buffett and other long-term investors advocate for buying high-quality businesses with durable advantages and holding them through market ups and downs. Emotional investing, such as panic-selling during downturns, can erode gains, so patience and consistency are crucial.

Investing Without a Broker

Thanks to commission-free trading platforms and apps, it’s now easier than ever to invest in stocks on your own. Many of these platforms offer fractional shares, allowing investors to buy a portion of a high-priced stock with as little as $5. While these tools make investing accessible, they also place the burden of research and decision-making squarely on the investor’s shoulders.

Most trading apps are designed for DIY investors and offer minimal guidance beyond basic robo-advisor suggestions. This means you need to be comfortable analyzing financials, tracking market trends and making independent investment decisions.

Tax Considerations for Stock Investments

One of the key differences in how you invest in stocks is how gains are taxed, especially when comparing tax-advantaged and taxable accounts:

Tax-Advantaged Accounts: Investing through retirement accounts like IRAs or 401(k)s allows your investments to grow tax-deferred. You won’t owe taxes on capital gains, dividends or interest until you begin withdrawals in retirement, potentially in a lower tax bracket.
Taxable Brokerage Accounts: If you invest outside of a tax-advantaged account, you’ll pay capital gains tax when you sell shares at a profit. The rate depends on how long you held the investment:
- If sold within one year, gains are taxed as ordinary income (short-term capital gains).
- If sold after one year, gains qualify for the more favorable long-term capital gains tax rate.

Tax planning is important, especially for high-frequency traders or investors holding large positions outside of retirement accounts.

Stock investing offers both opportunities and challenges. With the right strategy, a diversified selection of equities can serve as the cornerstone of a long-term wealth-building plan. However, success requires a clear understanding of risk, taxes and the market itself. If you’re new to investing, or unsure how to build a strong portfolio, consider consulting a financial advisor.

Investing in Futures

Futures contracts are fundamentally different from traditional stock investments. While buying stock means purchasing partial ownership in a company and benefiting from its appreciation or dividends, investing in futures involves agreeing to buy or sell an asset at a specific price on a future date. Futures are commonly used to speculate on price movements or hedge risk and are typically short-term in nature, maturing in a year or less.

The underlying asset in a futures contract can vary. It might be a commodity like oil or wheat, a financial instrument like a bond or stock index, or even a currency. Futures are traded on regulated exchanges such as the Chicago Board of Trade or the New York Mercantile Exchange, and the terms of each contract are standardized by the exchange. Unlike stocks, there’s no cap on the number of futures contracts that can be issued.

How Futures Work

When you buy a futures contract, you are not immediately paying for the asset. Instead, you’re entering a legal agreement to buy (or sell) the asset at a predetermined price on a set date. If the market moves in your favor, you stand to make a profit. However, if prices move against you, your losses can be significant, potentially more than your initial investment.

Let’s look at an example using commodities. Say you agree to buy 10,000 gallons of gasoline at $2 per gallon, and the market price rises to $2.25 per gallon by the expiration date. You profit from the $0.25 per gallon increase. But if the price drops to $1.75, you’re still obligated to pay $2 per gallon, resulting in a loss.

Leverage and Margin Requirements

Futures trading often involves leverage. You typically only need to put down a portion of the contract’s value, known as the margin, which allows for potentially larger gains but also amplifies your losses. Many brokers offer leverage ratios as high as 20:1 on futures, compared to 2:1 on stocks. That means a small change in price can lead to large gains, or devastating losses.

Margin accounts are marked to market daily, meaning you must maintain a minimum balance. If your position loses value, you may be required to add funds to your account (known as a margin call). This makes managing risk and maintaining liquidity critical when trading futures.

Risks of Trading Futures

Market Risk: Price movements can cause significant gains or losses. Futures are inherently speculative, and market conditions can turn quickly.
Leverage Risk: High leverage magnifies both profits and losses. A small unfavorable price move can wipe out your margin and result in a margin call or account liquidation.
Margin Calls: Because contracts are marked to market daily, you may be required to deposit more money even if the overall market hasn’t moved much.
Unlimited Loss Potential: Unlike stocks, where the most you can lose is your initial investment, futures can result in losses that exceed your original margin deposit.

Tax Treatment and Reporting

Despite the complexity of futures trading, tax reporting is relatively straightforward. Your broker will provide you with Form 1099-B, summarizing your annual trades. One unique feature is the 60/40 tax rule: 60% of your gains are taxed at the favorable long-term capital gains rate, and 40% are taxed at the short-term rate, regardless of how long you held the position.

Futures trading can offer access to diverse asset classes and potential profits through leverage, but it also comes with significant risk. It’s a fast-paced, volatile environment that requires active monitoring, strong risk management and a clear understanding of margin mechanics.

Because losses can exceed your initial investment, futures are typically best suited for experienced investors, or those working closely with a financial advisor.

Stocks vs. Futures

Both stocks and futures are commonly traded investment vehicles, but they serve different purposes and carry distinct risks, time horizons and costs. Comparing stocks vs. futures can help investors determine which better suits their financial goals and risk tolerance.

Similarities

Despite their differences, stocks and futures do share some common ground:

Liquidity: Both markets are highly liquid. Stocks can typically be bought or sold during trading hours with little delay. Similarly, futures contracts are actively traded and easy to enter or exit.
Diversification: Investors can diversify using either vehicle. Stocks offer exposure to a wide range of industries, companies and market sectors. Futures contracts also span multiple asset classes, including commodities, currencies and financial instruments.
Cash Flow Potential: Stocks can provide income through dividends, which are periodic payments made by companies to shareholders. Futures contracts generate cash flow in a different way, through daily mark-to-market settlements, which can result in either gains or losses depending on market performance.

Key Differences

The distinctions between stocks and futures become more pronounced when looking at cost, risk and time horizon:

Tax Treatment: Stocks are subject to capital gains tax rules. Selling a stock within a year results in short-term capital gains, taxed at ordinary income rates; holding for over a year qualifies for lower long-term capital gains rates. Futures are subject to the IRS 60/40 rule: 60% of gains are taxed at long-term rates and 40% at short-term rates, regardless of how long the contract was held.
Risk Profile: Futures involve significantly more risk than stocks, as losses can exceed the original investment due to leverage. In contrast, the maximum you can typically lose on a stock investment is the amount you put in.
Cost and Leverage: Stock investing generally comes with lower transaction costs, and you must pay the full purchase price (unless using margin). Futures often involve higher costs, including commissions and margin requirements. While leverage in futures can amplify gains, it also magnifies losses.
Time Horizon: Stock investments are typically made with a long-term outlook, making them suitable for retirement portfolios or wealth accumulation over decades. Futures, on the other hand, are short-term instruments with set expiration dates, usually less than one year, making them more appropriate for traders looking to profit from near-term market movements.

Bottom Line

To evaluate whether you should invest in futures or stocks (or both), you should consider all of these factors. Despite some of the pros regarding trading in futures, it is not a game for small or inexperienced investors. You need a thorough understanding of the futures market and help from your broker or other financial professionals. But, investing is a personal decision and it ultimately comes down to your own preference for risk, your time horizon and your investment goals.

Tips for Investing

Putting together a portfolio for retirement can be complicated, and you may want to consult with a financial advisor before making any investment. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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