Investing in stocks really isn’t as difficult as some people think. The first way everyone should be investing is through a 401k plan at work and then a private IRA at home. Most of that money should be invested in inexpensive index mutual funds and ETFs. Once you have your retirement covered, however, perhaps you wish to invest in individual stocks and try to pick some great companies that will outperform the markets over the next couple of decades.. Today I’ll go into how to buy individual stocks.
I chose $2000 since that is about the minimum amount you can invest and get a decent ratio of the commission you pay to the value of the shares. You should be paying commissions of 5% or less, and paying less than 1% is even better. You might pay 10% or more if you buy only a few shares. In general you want to buy stocks in 100 share increments. With $2000, you therefore can choose stocks with prices up to about $19, leaving a little room for the commission. You also generally want to avoid stocks selling for less than $10, since they tend to be more risky, although during big declines in the stock market such as the current slump you may find even great companies who have seen their share prices beaten down below the $10 mark. For example, right now I own shares of two retailers, The Container Store and Pier One Imports, that are selling in the $5 range because they have been beaten down during the current bear market. Both have also made missteps and seen a decline in their performance as well, however, so they do carry some risk since they may not find a way to turn things around.
If you are going to invest regularly you should setup a brokerage account. When I started investing all trading was done by phone with a broker. I had an account with Merrill Lynch, mainly because my father had an account with them (and because I was only 12 years-old, and didn’t really have a choice). Merrill Lynch is what is known as a full service broker, which is kind of like a full service gas station: You get a lot of bells and whistles and pay extra for them.
One of the biggest bells is a broker that you can talk to who can advise you on the best ways to make a trade, give you some stock picks, and do things like analyze your portfolio each year for issues. Today I really don’t need much advice, but I am still with Merrill Lynch out of inertia, sentimentality, for some of the other services they provide, and because I like to phone in orders and have a relationship with another person. Most brokers I’ve dealt with I’ve had as a broker for ten years or more. In addition, because I invest for the long-term and trade infrequently, the difference in commissions I pay versus a cheaper online version doesn’t really matter.
In the late 1980’s, discount brokers emerged. These brokers charged a lot less (50% less or more) than full service brokers because you didn’t get any frills or any advice. You simply called in an gave them your order and they did what you asked. You may or may not talk to the same person each time you called, so you probably wouldn’t build up a relationship with a broker. The creation of the internet and the ability to enter orders yourself has cut costs even more, making it possible to enter trades very cheaply, but again with even less personal interaction and advice. There are numerous online brokerages, the most famous of which is probably E-Trade.
With any broker, setting up an account is just a matter of calling or going online, giving some information, and sending in a check or doing a bank transfer to fund the account. Once you have an account there will normally be an account fee each year (I think Merrill Lynch charges $125 per year) to pay for the accounting they do. Most of the money they make is from commissions, which is a charge for making trades for you, interest charged when accounts go into margin (borrow money to buy stocks), or the normal bank process of lending out money you have in your account to others.
Normally when you have a brokerage account, the broker will keep the certificates for the shares you buy and put them in what is known as the street name. This means that to the company the shares will appear to be owned by your broker, but you will have a listing of what you own in your account. When the company sends information to the broker, such as yearly reports, the broker will forward the information to you.
If you want, you can request that certificates be issued to you. This may come with a small charge, plus it will then require you to protect the certificate since someone could theoretically steal it and then sell your shares and collect the money. If you choose to hold certificates, it is therefore a good idea to get a safe deposit box and keep your certificates there for safe keeping – both to guard against theft and fire. If you ever want to sell your shares, you would need to send the certificate back to the broker. Most people keep shares in the street name to avoid this inconvenience, but it might make some sense to keep certificates yourself if you were worried that the brokerage firm might dissolve and lose the record of your shares or something, but this is very unlikely.
If you just want to buy one stock and then hold onto it, you may be able to contact a broker and arrange to make the trade and then get the certificate sent to you. This will allow you to avoid paying the account maintenance fee each year. You may get charged a little more for commissions this way than they would with a standard account, but it can be done. Again, if you’re going to hold a stock for a long time, the difference in commissions won’t matter much. For building wealth, however, it is a good idea to be adding money and buying shares regularly. It is possible that you’ll buy a great company like the next Microsoft and be able to sell your 100 share certificate for hundreds of thousands of dollars in twenty or thirty years, but this is not that likely. Instead, by buying shares in different companies you make a 10-15% return each year and maybe have one or two stellar performers. By buying at different times, you can improve the price you pay for your stocks (because you acquire more shares when prices are low). By purchasing different companies, you increase your chances of having several winners and a few big winners.
Figuring out which stock to pick is a whole different matter and will be the subject of future posts and the next SmallIvy Book of Investing. In general you want to find a company that has a lot of room to grow and that is well managed. Factors to look at are the number of years that they have had profits and that those profits are growing at a steady rate, a share price that increases regularly but not at an enormous rate, and the return on equity and debt levels for the company.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.