How to Buy Stocks
Your image of stock trading may be people waving their fists of cash and shouting like an auction. But how do you actually buy stocks? What are some best practices to ensure you get the most out of entering the stock market?
How Do Stocks Work?
Stocks are effectively shares of a business. The company will pay you in one of two ways. The way you may be most familiar with is dividends. This is when a company pays out a portion of their profits. However, some companies choose to keep reinvesting back in themselves, so they’ll pay shareholders in a rising stock price. This means the stock you hold will go up in value from when you picked it up. You make money when the company outperforms market expectations or through the equity-risk premium (ERP).
How To Get Started with Stocks
Know your options. In addition to vetting the stocks themselves, you have to decide 1) how to buy, 2) how many shares and 3) your order type.
You’ll be buying stocks through a brokerage firm or an individual registered broker. Brokers are people who study the market and trade on your behalf, working for commission. The other option is to trade on an electronic trading platform like E*Trade or Ameritrade.
Then you’ll place either a market order or limit order. These are essentially two directions for your broker when making their judgments on your behalf. They operate on two different metrics: one vets a stock trade by execution and the other by price. This is all a complicated way to say that market orders are meant to close as fast as the market will allow. A limit order is when you set an upper or lower limit for what you’re willing to pay.
It’s possible to also buy stocks directly through the company. If you want to get in on what they’re doing at Disney or Dasani, you can purchase stocks directly without a broker through something called a DSPP or direct stock purchase plan. While you may typically think of stocks as bidding on individual stock, you can also buy mutual funds or ETFs. There’s a minimum investment required to open an account. However, beyond that there’s not much to start participating in the stock market.
When Timing Does (and Doesn’t) Matter
One thing to ask yourself before getting involved in the stock market is your time frame. Simply put, stocks aren’t for making money in the short term. Rather, those who enjoy the most success with stocks hold them for a long time. How long you have before you wish to see a return is called your “time horizon.”
The flipside of this fact is there’s no perfect time to buy stocks. You can’t predict the next Apple, so there’s no material benefit to delaying getting involved in the stock market.
How to Select the Right Broker
How to select the right broker? Factors include how much you can spend on this endeavor and how often you intend to trade. Are you looking to be a more casual trader? Are you looking to be engaged and follow the market intently? Additionally, consider how much support you want from your broker. There are also brokerages that broker without humans.
What to Look For in a Stock
Stocks are evaluated a few different ways. One metric you might have heard of is the P/E or price/earnings ratio. You can find these in stock tables. Stocks with a P/E higher than the market average are considered expensive.
Keep in mind that the P/E can’t tell you everything. You also want to consider the P/E relative to the growth rate. So if a company is expanding quickly, the P/E will look more impressive.
You also want to look at the business itself. Does it show promise? Do they seem ethical? You’ll be choosing a sector of the market to spread your investments in (like defense, education, etc). Pick an industry that makes sense for you. If you’re someone who follows cars or airlines, you’re going to understand the SWOT better than someone who doesn’t.
Why You Want To Diversify
You hear stories of lucky people getting in early on a venture, but you don’t want to hang your hat on one company. Otherwise when they tank your portfolio will take a bigger hit. A good rule of thumb is to not let any one investment represent more than 5% of your portfolio. It’s advisable to diversify your stock options rather than trying to divine the next big thing.
The Bottom Line on Stocks
With the rise of self-improvement and life-hacking, there are endless resources out there claiming to have the secret to instant wealth. In order to get the most from stocks, you need to approach them in a methodical and educated way. Be prudent with your finances - which sometimes means taking calculated risks.