Stocks vs CFDs: The Key Differences
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Investment in stocks has a long-standing reputation for the potential to earn big returns for those who can navigate the ups and downs of the trading markets.
An investment opportunity that is becoming increasingly popular, however, is the use of CFDs (Contract For Difference).
Where purchasing stocks in a business means that you own that stock, a CFD simply matches the value of a stock or commodity without the element of ownership.
If you think a course in trading might benefit you, read The Best Stock Trading Courses.
Key Differences Between CFDs and Stocks
Both stocks and CFDs are viable trading options; however, there are key differences between the two investment opportunities:
What Do You Own?
This is the main difference between CFDs and stocks. When you purchase stocks, such as shares in a business, you own those stocks until you sell them.
With CFDs, there is no element of ownership. What you have instead is a contract with a broker.
The advantage of ownership, in this context, is the related range of shareholder perks and benefits. For example, voting rights or the option to attend shareholder meetings.
Another benefit of stock ownership is the payment of dividends.
If you purchase CFDs concerning company shares, the likelihood is that you will be paid a dividend if you have a CFD in place at the time when dividends are released to shareholders.
However, the conditions surrounding that dividend, such as the amount paid out, will vary from the dividend arrangement for a stockholder.
Financing the Investment
Once an investor in stock has spent their investment pot, they cannot make new purchases without the sale of their existing stocks.
However, a CFD investor has the opportunity to pay a percentage of the stock price and borrow the remaining amount from their broker.
This is known as leverage trading.
James and Michael each have £10,000 to invest. James uses his £10,000 to buy 19 Tesla shares priced at £502 each, leaving him with £462 unspent.
Michael is also interested in Tesla, but instead of using most of his money in a straightforward stock purchase, he arranges a CFD with a 10% margin.
He invests £954 and borrows the rest of the money from his broker. Michael then has £9,046 remaining to invest elsewhere.
To find out more about Leverage Trading, read What Is Leverage in Forex Trading?
What Can You Invest In?
If you invest in stocks, you are generally limited to purchasing business shares or exchange-traded funds (ETFs). An ETF is a collection of securities that are traded on an exchange.
Speed of Cash Settlement
Should you sell all or a portion of your stocks, you can expect to wait at least a couple of days before you receive the cash settlement.
However, when you sell your CFD, or it comes to an end, you will be paid immediately. The benefit to an immediate cash settlement is the speed with which you can reinvest your money or take it as income.
If you invest in stocks, your trading will be limited to stock exchange hours. This is generally from 8:00 a.m. to 4:00 p.m. Monday to Friday in the UK.
Stock exchanges are closed for trading on a weekend and for bank holidays.
If you invest in CFDs, however, which are open to a wider range of investment instruments (forex, commodities, etc.), you have access to many more markets.
Therefore, you can generally trade for twenty-four hours every day.
Length of Investment
Your decision to invest for a short length of time (be that hours or days) or on a longer basis (stretching from weeks to even years), will inform your choice of stocks or CFD investment.
CFDs can be used for short or long-term investments, but are especially suited to the short term because many of the investment instruments they trade-ins, such as cryptocurrency or forex, are subject to rapid rises and falls in price.
By comparison, stock trading is not suitable for short-term investments because it relies on a buy-and-hold strategy and restrictions linked to actual ownership of stocks which may prevent a quick sale.
In terms of taxation, stocks and CFDs are considered two different things by the HMRC.
Stocks are an asset, while CFDs are simply an agreement because of the lack of ownership. Nevertheless, both carry a tax liability.
Stocks are taxed in several ways:
- Capital gains tax
- Stamp duty
- Dividend tax, if appropriate
Where the profit you make from selling stocks is greater than the capital gains tax-free allowance, £12,300 in 2021/22, you will be liable to pay capital gains tax on the portion of your profit over the allowance.
The calculation of the amount you pay, however, can be complicated by the rate of income tax you would normally pay.
As a basic rate income taxpayer, the amount you pay will depend on how much income you earn, your income tax allowance, and what profit you made from the sale of your stocks.
For example, Taxable income (income less personal income tax allowance) – £10,000.
Taxable gains (income from the sale of stocks with fewer expenses) – £15,000.
Deduct the capital gains tax-free allowance from your taxable gains – £2,700.
Add this to your taxable income – £12,700.
If the resulting amount is within the basic income tax band, £37,700 in 2021/22, 10% will be paid on your gains, and if it is above, you will pay 20%. In this instance, the amount is within the tax band, and the tax liability is, therefore, £127 (10%).
If you are a higher rate income taxpayer, you will pay 20% capital gains tax on your taxable gains.
Stamp duty generally comes into effect if you buy shares at a rate of 0.5%.
Should you receive dividend payments, these will be added to your income.
There is a dividend tax-free allowance of £2,000 (2021/22). Should your dividend earnings be more than £2,000, the percentage you are charged will depend on your income tax band:
- Basic tax band rate – 7.5%
- Higher tax band rate – 32.5%
- Additional tax band rate – 38.1%
CFDs are generally taxed in the same way as stocks, except stamp duty. As the CFD is not an asset and, therefore, no transfer of ownership has taken place, stamp duty does not apply.
CFDs are subject to capital gains tax and, where appropriate, dividend tax.
Taxation Example One:
Jane’s taxable income is £7,000. She sells the stock and makes a profit of £19,000. In the current tax year, she also received dividend payments of £1,995.
Once the capital gains tax-free allowance has been deducted from her taxable gains, the remaining amount is £6,700. When added to her taxable income, this results in an amount of £13,700.
As this amount is within the basic income tax band, 10% is applied. Her capital gains tax liability is £137. Her normal tax rate will also be applied to her taxable income.
There is no tax liability on her dividend payments because they are within the dividend tax allowance.
Taxation Example Two:
Marie invests via CFDs. Her taxable income is £10,000. Trading CFDs, she makes a profit of another £10,000. She receives no dividends.
The amount of her CFD earnings is lower than the capital gains tax-free allowance and results in zero capital gains tax liability. However, her normal tax rate is applied to her taxable income.
Which Is the Best for You?
There is no straightforward answer to this question. It will depend on your personal needs.
Factors to consider include:
- Do you actively want to own shares in a business and enjoy the privileges that bring, such as voting powers and dividend payments? In which case, investing in stocks is the path for you.
- Are you more, or at least equally interested in being involved with a particular business over making a profit? If yes, then stock trading is your best choice.
- CFDs are your best bet if you want to invest in instruments not available to stock traders, such as commodities or cryptocurrency.
- Do you want to make a short-term investment, selling after a couple of days? Again, CFDs are your best choice.
- How much money do you have to invest? Using leverage trading, CFDs may give you access to the same opportunities as buying stock but for a smaller initial outlay of money.
- Do you want to trade at any time, or are you happy to trade within stock exchange trading hours only?
CFDs vs Stocks: Advantages and Disadvantages
If you are still unsure which type of investment will suit your needs, maybe you should consider the benefits and downfalls of each option:
- The option to use leverage investing so you can spread your investment pot
- Can be used for both short and long-term investments
- Opens up a wider range of investment instruments than stock trading
- Higher risk of losing money
- Leverage investment is complicated and can prove difficult for a beginner
- The benefits that accompany stock ownership
- You own the stocks
- The chance to be involved with a particular company or trend
- Only able to trade when the stock markets are open
- Not suitable for short term investment
The Best Places to Trade Stocks And CFDs
Whether you decide to invest in stocks or CFDs, having a range of places where you can trade them is always useful.
Here are some great options:
Established in 2007, eToro offers both stocks and CFD trading opportunities. They charge 0% commission on stocks trading and, through their patented software CopyTrader, the opportunity to copy the portfolios of top-performing traders.
eToro also features an online community in which you can join discussions with fellow traders and learn more about trading.
***67% of retail investor accounts lose money when trading CFDs with this provider.** You should consider whether you can afford to take the high risk of losing your money.*
2. Plus 500
Plus500 is a UK-based trading provider offering a CFD service only.
Plus500 offers a free app for trading on the go, which provides a demo mode to learn how to trade before you make an actual investment.
72% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.
3. City Index
Originally established in the UK in 1983, City Index offers investment opportunities across the stocks, commodities, indices and forex markets.
In addition to its service provision, City Index also offers training videos and tutorials on trading.
IG is a worldwide, award-winning, forex (foreign exchange) trading provider, which has been in existence for over 45 years and is registered with both the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA).
As stock trading does not cover the forex market, this provider is only suitable for CFD trading in this instance.
5. CMC Markets
CMC Markets has operated as a trading provider for over 30 years across a wide range of markets, making it an ideal provider for both stock and CFD investments.
Its mobile trading app, suitable for both iPhone and Android, makes trading on the move an easy option.
Stocks and CFDs are both viable trading options and offer the opportunity to make big profits if handled correctly.
The decision on which to choose will, however, depend on your personal situation, your trading expertise and what you want to achieve in the short or long term.
WikiJob does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
ESMA risk warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.