What are Stocks?
Stock (also known as equity or shares) is how a company is proportionately split between people who are known as shareholders/stockholders. Stock in a company is bought and sold both on the stock market and through private sales.
A corporation may offer to sell some of its stock to raise money to operate their business. A stockholder can purchase stock from that company. Depending on the percentage of the purchased stock, the stockholder has a claim of the company’s assets. As well as the money to be made, you can also vote on the future direction of the company with a higher share, offering more sway.
Owning over 50% percent of the company’s stock makes you a major shareholder. This gives you a major vote in the company’s direction, along with the ability to appoint the board of directors. The major shareholder is usually the founder of the company, but this is not always the case.
How to Start Investing in Stocks
In 1986, when Bill Gates released Microsoft stock purchases to the public intending to raise money, he owned 46% (11.1 million pieces of stock) of the shares. Each share was worth $21 at the time of opening the sale. As the company grew, stock split into multiple pieces and now Bill Gates only owns 1.3% of the company stock; but, at the time of writing, he had a net worth of $103.4 Billion. If you decided to invest in 100 pieces of Microsoft stock in 1986 and sat with that investment through multiple stock splits until 2011, the stock you bought for $21 a piece, would be worth $750,000.
To summarise, if a company has 1,000 pieces of stock at $1 apiece and you invest in 100 of those pieces, you now own 10% of the company. If the business continues growing and each stock has now increased in value to $3 apiece, you and the other shareholders can decide to split your stock into three pieces. That results in 3,000 pieces of stock of which you own 300 again at $1 apiece. A company can keep growing and splitting until it becomes Microsoft or even larger. Buying and selling stocks is a great way to reach your planned financial goals if done right. Buying stocks has proven to be one of the most profiting forms of investing. If you don’t have a plan for your financial future, check out our article.
Stocks and Dividends
Some stocks also pay out dividends. Companies who offer this type of stock will pay out regular dividends to their shareholders. Stocks that provide dividends are usually from well-established companies. The payable amount is set by the board of directors who are appointed by the major shareholder though any shareholder with a vote can help decide the amount. As an example, if your share is worth $20, then the agreed dividend might be $2 per share.
Dividends can be paid out in cash, stocks, or other property; however, cash is the most popular. If you have a preference for stocks over cash, then you can see if the company shares also offer a dividend- reinvestment plan. The company pays your dividend to you in stocks which are usually offered at a discounted rate and without brokerage fees. Using the example above, if you opt for shares and you hold 100 shares of that company at $20 apiece, then you would receive ten shares.
Profits From Stocks are Taxable
Any profit you make on stocks that are held for a year is taxable. It is taxed at 15% if you are in the higher tax bracket or 5% in the lower bracket. Profits made from stock held for less than a year are taxed at your normal income rate. The practice of tax-loss harvesting is to sell specific pieces of stock at a loss to offset your profit and thus lower your tax liability.
Common Types of Stocks
Considering investing your time and money into buying and selling stocks? Know that two main types of shares are available to invest in on the stock market.
There is common stock, which is the type described above. If you invest in this type, you will be given the right to vote in the direction of the company. If a company goes bankrupt, you would be the last in line, after debtors and the below-described preferred stockholders, to receive your percentage of financial assets from the company. Despite the risk, the common stock tends to outperform preferred stock in the long run.
Preferred stockholders have minimal, or sometimes no voting rights but do, however, have a higher claim to financial assets of the company.
It is important to note that even if you do own a percentage of a company’s stock, it is not the same as owning a portion of the company. In the U.S., a company is treated as a singular person, meaning physical assets such as office desks and chairs belong to the company despite the stock you own.
This is important, as company property is separate from your property even though you own a share of the company. If a company went bankrupt, its assets might need to be sold, which will not affect you personally. On the contrary, if you were to go bankrupt, you could sell your stock but not a physical percentage of the company.
Other Types of Stock
Another form of stock we haven’t mentioned when looking into buying stocks is penny stocks. A penny stock is not too different from the stocks mentioned above. You are purchasing a share in a company.
A stock is classified as a penny stock when the price is valued at less than $5, and most of these types of stocks cannot be purchased through the national stock exchange. They are usually associated with small companies and come with a particular appeal due to their possibility to grow. They can be purchased through your stockbroker; however, they do come with a large amount of risk. They are cheap to buy, but the market to sell is much smaller than your usual stocks and finding a buyer at the right time may prove difficult.
Approach penny stocks with caution as they have been associated with the term “pump-and-dump.” This phrase means to buy cheap, advertise their worth as being more than they are and then sell. This is not an effective strategy for selling stock, nor is it ethical and is probably illegal. I imagine you have seen the movie ‘Wolf of Wall Street.’ If so, Jordan Belfort dealt in penny stocks using the above strategy. You saw how that movie ended.
How to Buy Stocks
Now we know what they are, we should find out how to buy and sell stocks. Stocks are purchased through the stock market or through a direct stock purchase plan, which is a service that allows you to buy directly from the company (often without fees and at a discount).
There are two primary ways to buy stocks:
- You can choose how you will be investing on your own.
- You can trust a professional to act as a financial advisor and handle your investment for you.
Either way, you will need to open a brokerage account through a brokerage firm. You can either open an online brokerage account to buy shares or visit a physical office; however, with the use of the internet, these are becoming less and less. Either option will charge a commission, flat rate or both depending on the firm.
Once you have an account, you will need to deposit cash into that account and then you are ready to start buying stocks.
How to Buy Stocks on Online Platforms
If you plan to explore the world of stocks and shares alone, then an online platform to sell or buy stocks is your best approach. Your broker may have a platform you can use. As an alternative, you can also use an online discount broker site such as E*Trade or Ally Invest. These are two of the more well-known brokerage platforms that charge a lower commission than a full-service broker.
Alternatively, you can entrust your investment account to a full-service broker to do the work for you. A higher commission will be taken versus buying and selling stocks online (the amount of which can differ per firm and the amount of trading you wish to do).
You will have more security with having a professional dealing with your investing decisions. They can offer advice on the best investments along with having a better ability at predicting whether the stock market price will rise or fall. You can then decide on what type of stock to buy/sell and how much you are willing to spend and then leave the broker to increase your investment hopefully.
How Brokers Work
You will not be left without control; however, as there are four main ways that a broker can act on your behalf:
You can agree to what is called a market order, which is the most straightforward order to place. You buy your chosen stock at the average market price and then sell at a time of your choosing without thinking too much about the selling price. This method is better for large companies whose stocks won’t increase/decrease massively over the trading day.
Alternatively, you can set a limit order. As a simple example, let’s say you want to buy Apple stock. You can stipulate with your broker that you wish to buy Apple stock at $207 apiece. Your broker will then wait until the stock comes down to that price before they begin trading on your behalf. A limit order can also be set for the selling of your stock, and it will not be sold until your stock reaches that price or higher. You are choosing to set a maximum/minimum amount at which to buy and sell. Limit orders usually incur a higher commission as it can take longer to sell at your requested price. With the market always moving, there may not be enough time to sell all of your stock that day.
The commission is taken per trade. If a broker can only sell 20 pieces of your 1,000 shares a day while getting your requested price, then the extra work comes at a cost. To make the most of this type of order, it should be set on the stocks of a smaller company that can experience major fluctuations throughout the day. A limit order may be a good strategy for what is known as growth stocks; a company that is growing fast, however, has a high risk of failing. The fast growth can offer higher returns, but there is a higher risk of bankruptcy as most growth stocks are offered by companies that are young and upcoming. A limit order provides the necessary protection.
Buy or Sell Stop Orders
A buy or sell stop order is set above/below the average market price. For buying stocks, you set a buy-stop order above the market price on the basis that the stock would then keep rising. It has been used as a strategy to later sell your stock quickly in that rise, making a profit. A sell-stop order is the reverse and set below the market price. If the share reaches this price, you will sell your stock to limit further loss.
A stop order which can also be known as a stop-loss order is different from a limit order in that it does not wait for a specific price of the shares but waits for the price to move past a particular point. The order then turns into a market order, and as the price of an individual stock is always moving, unlike a limit order, you may not get the price you intended.
There are a couple more orders you can arrange with your brokerage firm, on top of the four main types we described above. For example, a stop-limit order is a combination of a limit order and a stop order.
For buying, let’s say the stock in which you are considering investing is currently worth $20, but you expect it to rise in the day. You can then set a stop price of $25, meaning you won’t buy until the stock reaches that amount and then set a limit order at $28 giving you the time in between to meet your order. For selling, the reverse applies. You set a stop order at what you wish to sell and then a limit order and the lowest amount you are willing to sell.
As Seen on TV
Etoro is a trading platform for buying online stocks that have gained traction in recent years for being accessible to anyone, anywhere. It claims to provide easy access to beginners wishing to open their first brokerage account and to buy and sell stocks online while offering enough tools to be useful to experienced investors. It started as a commodity trader (gold, silver, oil, etc.) before introducing stocks in 2012.
The application sets itself apart from other online brokers by using machine learning to establish what it calls copy trading. You may have seen the ads on YouTube explaining how a lazy Dave is as efficient at stock trading as Steve, who spends much of his time researching how best to be investing his money. The principle is that you can allocate a fixed amount of money and choose an established stock trader, who is represented as Steve (whose statistics are available for viewing before you commit) and then the application will copy the actions of the selected trader without any input from yourself making you a successful trader like Dave.
Another reason Etoro has become so popular is that, unlike other platforms, it does not charge a commission or trading fees. However, it is not without cost and does charge a $25-dollar withdrawal fee with a minimum of $50 withdrawal to your bank account.
Do I Need Money to Make Money?
It is generally believed that you need thousands of dollars to open a brokerage account and to start investing. This is not the case with the only limit being the initial fee to open an account (some of the best brokers do not even charge a fee to open an account).
You should also factor in the commission of the broker (whether online or in-person) on any of your buying and selling. Online brokers tend to be cheaper; some known to take only $4-$5 per trade where an actual physical stockbroker may take somewhere between $30 to $45. A good starting amount is $500 for your first day of trading. However, don’t spend what you can’t afford to lose.
There is a possibility to make big money with stock trading but also a possibility to lose a lot as well. You need a high risk tolerance if you start to panic as stock prices drop; you may sell too low and lose money or miss out on a potential rise.
Before considering investing in stocks, work out your budget. If you put away $10 a week of your hard-earned money, within a year, you will have your $500 ready to go. You could save your money in an envelope, a cookie jar, or even open a high-interest savings account (tips on finding the best savings account can be found here).
The Importance of Diversity
Now that you have your $500 ready to begin investing in stocks, you have a broker account and are fluent in stocks, the next step is deciding what to invest. The collection of stock you are about to accumulate is called a portfolio, and what stock fills your portfolio is up to you. You can buy an individual stock in one company only, or you can choose to purchase shares in multiple companies, some with low risk and others with high risk but the possibility for high reward.
Mixing Up Your Portfolio
The general rule is that it is always better to diversify and avoid solely relying on buying individual stocks. You wouldn’t go for a walk at night carrying all of your wealth.
In the same way, you wouldn’t invest everything in one company that could suffer a major drop in share prices for any number of reasons. Regulatory issues, poor management, or even something as unpredictable as a hurricane hitting their office could all lead to a drop in what your stock is worth. It will take time, patience, and research, but you know that you have more security with a more extensive selection of stock. If you don’t have the time and patience, then there are other options for investing in multiple stocks, detailed below.
A mutual fund is a pool of money put in by multiple investors, an investment objective is set, and then a money manager will invest that money in multiple individual stocks. This is a great way for entry-level investors to gain access to a professionally managed portfolio. There will be an annual cost attached to maintaining the mutual funds and possibly a commission depending on the manager of the portfolio. Both mutual funds and ETFs have been known to pay out dividends.
An index fund is for someone who is looking to be in the investment game for the long haul without having to pay too much attention to the market. An index fund is an extensive collection of companies that all have similar stocks. The most well-known index fund is the S&P 500, which is a collection of stock from 500 large companies. It is a generally safe investment with small expenses. With the stock increasing over several years, rather than selling for an immediate profit, there is a limited amount that can be made.
Exchange-Traded Funds or ETFs
An exchange-traded fund or ETF is a collection of stocks that have been accumulated by an ETF provider. It comes with the benefit of multiple stocks in one place like the mutual funds’ system as well as the ease of buying and selling of single stocks. ETFs made up 30% of all U.S. trading in terms of value in 2016. The appeal comes from the simplicity of it along with access to an already diversified portfolio. The original idea behind ETFs was long-terms investments; however, these days, it is generally traded like any other stock.
Taking Stock of Things
It is clear that stocks are not for everyone, but if you have the spare funds to invest and the time to do the research, then it is worth consideration.
There is always the risk of making a poor decision on the stock market and losing your investment. Sensible investing can avoid this, and if that is a major concern of yours, then a professional stockbroker may be the best option to ensure you invest wisely.
As we clarified, you do not need a huge initial financial input to start investing. There is also the potential to make substantial financial gains with time, knowledge, and a bit of luck. People have made buying and selling stocks their sole source of income. Mutual funds are a great starting point for investing in stocks and much more reliable than individual stocks for a beginner who is looking to get on the investment ladder.
A well organized and maintained stock portfolio may serve as a backup for the future and even the way to a secure retirement (see index fund above). With the above information, you should be ready to invest in stocks.
Do you feel like you know how to buy stocks now? Is there any company in which you would love to invest?