Investmentsmaidav Basics
ETFs, Individual Shares and Bonds Compared
Three building blocks, three characters: how ETFs, individual shares and bonds differ in returns, volatility, effort and cost.
Anyone who wants to invest money on the capital market soon comes across three basic building blocks: exchange-traded index funds, individual shares and bonds. Each follows its own logic. The first bundles hundreds of companies, the second relies on a single firm, and the third promises fixed interest for a set period. This article explains where the return comes from in each case, how much prices fluctuate, what effort and costs are involved and how investment income is taxed in Germany.
ETFs bundle an entire market
An ETF (exchange-traded fund) is an investment fund that is traded on the stock exchange and, in its classic form, tracks an index, such as a broad equity index of several hundred companies. To do so, the fund either buys the securities in the index itself (physical replication) or reproduces their performance through swap agreements with banks (synthetic replication). With a single security, investors thus obtain a degree of diversification that individual stocks would only provide with a large amount of capital.
An important safeguard lies in the legal structure. The fund's assets are kept separate from those of the fund company. Under German law they form a segregated pool of assets (Sondervermögen) that is not liable for the debts of the asset management company (Kapitalverwaltungsgesellschaft) and does not form part of its insolvency estate if it fails. Many of the ETFs traded in Germany come from other EU countries; there, too, the European fund rules separate investors' assets from the company's own assets and require a depositary. None of this protects against falling prices: if the tracked market falls, the ETF falls with it.
The ongoing costs of an ETF are stated as a percentage per year, often under the abbreviation TER (total expense ratio). They are not invoiced separately but are deducted continuously from the fund's assets, which reduces its performance. Because a passive index fund does not engage in elaborate stock picking, its fees are usually lower than those of actively managed funds, according to BaFin, the German Federal Financial Supervisory Authority.
Individual shares rely on a single company
Buying a share makes you a part-owner of a company. The return comes from two sources: dividends, when the company distributes part of its profit, and changes in the share price, which reflect the market's expectations of the company's future development. If you deliberately select individual companies, you can benefit more than the average from their success, provided your own assessment turns out to be correct.
The flip side is concentration. If things go badly for one company, the full impact feeds through to the value of your portfolio, whereas in a broad index it is cushioned by the other holdings. Then there is the effort involved: analysing annual reports, comparing competitors, putting valuations into context. The article on reading company balance sheets shows how to go about it. A portfolio of several individual stocks also needs enough capital so that order fees do not weigh disproportionately on the result.
Bonds lend money for a fixed term
A bond is an interest-bearing security through which governments, German federal states (Länder) or companies borrow money. The buyer usually receives a fixed rate of interest, the coupon, and gets the nominal value back at the end of the term. How reliable these payments are depends on the issuer's creditworthiness, that is, its ability to pay the interest and repay the principal. Rating agencies summarise this assessment in grades, and weaker creditworthiness usually goes hand in hand with higher interest rates. Bonds are not covered by any deposit guarantee scheme.
During the term, the price fluctuates. If market interest rates rise, newly issued bonds become more attractive and older securities with a lower coupon lose value. If rates fall, the reverse applies. This interest rate risk is all the more pronounced the longer the remaining term. If you hold a bond until maturity, you get the nominal value back, provided the issuer remains solvent; price fluctuations along the way only affect you if you sell early.
The three building blocks side by side
- Source of return: ETFs and shares live on price gains and dividends, bonds mainly on interest.
- Volatility: individual shares usually fluctuate most, broad equity ETFs less, and short-dated bonds of good credit quality generally least.
- Effort: a broad ETF needs little ongoing attention, while individual shares call for research and regular review.
- Costs: all three incur order fees and a bid-ask spread, and ETFs also carry ongoing fund costs.
- Diversification: an ETF diversifies automatically within its index, whereas with individual stocks diversification only comes from holding many positions.
- Predictability: bonds held to maturity provide predictable payments, as long as the issuer pays.
None of the building blocks is inherently superior. They perform different tasks, and many investors combine them. Which mix suits you depends on your goal, your investment horizon and how much fluctuation you can bear, both financially and emotionally. This is a personal judgement and there is no blanket answer to it.
What buying and holding securities costs
Besides the ongoing fund costs, all three building blocks involve transaction costs. These include the order fees charged by the bank that keeps your securities account, stock exchange fees where applicable, and the bid-ask spread, that is, the difference between the price at which you buy and the price at which you could sell at the same moment. Some institutions also charge a fee for maintaining the securities account. Before a purchase, the bank must disclose the expected costs.
A savings plan, in which a fixed amount is invested at regular intervals, is common for ETFs and is also offered for some shares. It spreads purchases over time and takes the question of the right moment to buy out of the equation. Even small differences in cost become noticeable over many years because they erode the compounding effect. You can work out by how much with the compound interest calculator.
How investment income is taxed
In Germany, interest, dividends and capital gains from securities are subject to the German capital gains tax (Abgeltungsteuer) of 25 per cent (Section 32d of the German Income Tax Act, EStG). On top of this come the solidarity surcharge (Solidaritätszuschlag) of 5.5 per cent of that tax and, where applicable, church tax. The bank usually withholds the tax directly. The saver's allowance (Sparer-Pauschbetrag) of 1,000 euros a year remains tax-free, or 2,000 euros for married couples assessed jointly; these amounts have applied since 2023. For the bank to take the allowance into account, it needs an exemption order (Freistellungsauftrag).
Equity funds have a special feature, the partial exemption (Teilfreistellung). If, according to its investment terms, a fund continuously invests more than half of its assets in shares, it counts as an equity fund for tax purposes, and 30 per cent of the income remains tax-free for private investors (Section 20 of the German Investment Tax Act, InvStG). This offsets the fact that funds already pay tax themselves on certain income. For funds that reinvest their income, an advance lump sum (Vorabpauschale) is also applied each year, the amount of which depends on the base interest rate (Basiszins). Losses from selling individual shares can only be offset against gains from selling shares.
| Gain on the sale of an equity ETF | €3,000 |
|---|---|
| Partial exemption 30 % | €900 |
| Taxable portion | €2,100 |
| Less saver's allowance | €1,000 |
| Tax base | €1,100 |
| Capital gains tax 25 % | €275.00 |
| Solidarity surcharge 5.5 % | €15.12 |
| Total tax excluding church tax | €290.12 |
The example assumes a private investor who pays no church tax, a fund that counts as an equity fund for tax purposes and a saver's allowance that has not yet been used; it is deliberately simplified. For an individual share with the same gain, there would be no partial exemption, and the tax would come to 527.50 euros.
No building block is better than another; what matters is the task it is meant to perform in the portfolio.
ETFs, individual shares and bonds are not competitors but tools with different characteristics. ETFs offer broad diversification at manageable cost, individual shares the chance to participate in selected companies, and bonds predictable interest and usually calmer prices. If you understand the mechanics behind returns, risk, costs and taxes, you can compare offers soberly and make decisions that suit your own situation.
Frequently asked questions
What happens to an ETF if the fund company runs into difficulties?
The fund's assets are kept separate from the company's assets and are held by a depositary. In Germany they form a segregated pool of assets (Sondervermögen) that is not liable for the debts of the asset management company and does not fall into its insolvency estate. This protection only concerns the separation of assets: investors still bear any price losses in the tracked market themselves.
Why do bonds lose value when interest rates rise?
A bond pays a fixed coupon. If the general level of interest rates rises, new bonds offer higher interest, and older securities only find buyers at a lower price. The longer the remaining term, the stronger this effect. If you hold the bond until maturity, you get the nominal value back, provided the issuer remains solvent.
What does the partial exemption for equity funds mean?
For funds that continuously invest more than 50 per cent of their assets in shares, 30 per cent of the income remains tax-free for private investors in Germany. Only the remaining 70 per cent is subject to German capital gains tax. For mixed funds with an equity share of at least 25 per cent, half this rate applies. Individual shares and bonds have no partial exemption.
How do I use the saver's allowance?
With an exemption order (Freistellungsauftrag), you tell your bank up to what amount it should pay out investment income without deducting tax. All your orders together may not exceed 1,000 euros, or 2,000 euros for married couples assessed jointly. If the allowance was not used up during the year, you can still claim it afterwards in your tax return.
Terms
- TER
- The total expense ratio states a fund's ongoing costs as a percentage per year, which are deducted from the fund's assets.
- Segregated fund assets
- Fund assets held separately from those of the fund management company (Sondervermögen under German law), which are not liable for the company's debts.
- Interest rate risk
- The risk that the price of a bond falls because the general level of interest rates rises.
Sources
- Exchange traded funds (ETFs) at a glanceFederal Financial Supervisory Authority (BaFin)
- Bonds: an overviewFederal Financial Supervisory Authority (BaFin)
- § 32d Einkommensteuergesetz, Gesonderter Steuertarif für Einkünfte aus Kapitalvermögen (in German)Bundesministerium der Justiz, gesetze-im-internet.de
- § 20 Einkommensteuergesetz, Kapitalvermögen (Sparer-Pauschbetrag) (in German)Bundesministerium der Justiz, gesetze-im-internet.de
- § 20 Investmentsteuergesetz, Teilfreistellung (in German)Bundesministerium der Justiz, gesetze-im-internet.de
Image: illustration, created with AI.
