A Beginner's Guide to Buying Stocks

Image: graphic illustration of stock market. Title: A Beginner's Guide to Buying Stocks
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Whether it’s the ticker running across the bottom of your screen, or the numbers filling up the business section in the newspaper, the stock market is everywhere. For many of us, buying stocks remains a mysterious, and oftentimes overwhelming, thing. But history has shown that, over the long term (ten years or more), the stock market almost always grows more than virtually any other investment—so it is likely worthwhile for you to roll up your sleeves and learn whether investing in individual stocks is for you, and how you can get started.

Even if you don’t have the money to develop a large, diversified portfolio of stocks, you can consider investing a small amount in a company you believe in—thus playing an even bigger role in the movement for sustainability in the marketplace.

Is Buying Stocks Right for You?

A share of stock is a piece of ownership in a given company. When a company “goes public,” it sells off shares of ownership to investors as a way to get initial capital to grow its business; then, investors take over and start trading shares of that stock among themselves. When stock is traded on the stock market, the price of a stock at any given time is determined by what price is being asked, and what other investors are willing to pay.

Your stock investment strategy will differ depending on your investment goals and the overall size of your portfolio. Most financial advisors recommend maintaining a good diversification (i.e. variety) of stocks to reduce risk.

Christine McHugh, a Colorado-based financial advisor, recommends having a portfolio of at least $100,000 before turning your attention to individual stocks, which many experts say should comprise no more than ten percent of your total investment portfolio. She advises those of us with less than $100,000 in our portfolio to invest in the stock market primarily through mutual funds and other vehicles that offer instant diversification. 

But what about those of us who don’t have a $100,000 portfolio but want to be part of the growth of a company we find exciting? In that case, most advisors say go ahead and make an investment, just know what you’re getting into.

“Investing in a company you believe in is great,” says financial advisor Dena Frenkel .“But you also have to accept that restricting your stock holdings to one or two companies is a riskier venture than spreading a larger amount of money around between many different companies.”

McHugh says that people with less than $100,000 should limit their investment in individual stock to five percent of their total portfolio. Also, other experts recommend that you not use essential funds, like those you’ll need for your retirement, on these small investments, and advise adjusting your investment perspective so that, as Frenkel says, “you’re not investing simply to make money, but to help a company you believe in grow stronger.”

Find a Broker 

To buy and sell stocks, you need a broker to perform the transactions for you, because only licensed members of the stock exchange are allowed to conduct stock transactions. There are two categories of brokers: full-service and discount.

full-service broker has access to research and analysis of the financial performances of publicly held companies, and can offer investment recommendations. Any financial advisor who is registered as such or has a securities license can act as a full-service broker. 

Some full-service brokers will charge you commission, so you pay a fee every time you buy or sell stock; this is the costliest way to trade stock, and it’s to the advantage of this type of broker that you buy and sell often. Other full-service brokers are paid a single fee for all of the assets under management, along with a small (about $10) charge for each stock transaction; some of these brokers may have minimum account requirements.

Although using a full-service broker is more expensive than using a discount broker (see below), there is one big advantage: If you tell your broker about a company that interests you, she or he will look into its past performance and recommend whether or not it’s the right stock to match your investment goals.

Discount brokers don’t provide the advice you’d get from a full-service broker, but they are also less expensive. Discount brokers simply make your transactions for you. Many discount brokers let you do your trading through the Internet, so you can track your stocks and issue transaction orders 24-7, without speaking to anyone. 

Most online discount brokers have an account minimum of between $1,000-$2,500, and charge a fee of about $10 for each online transaction. Some offer the option of trading by phone, or with the assistance of a live broker—both options are more expensive, costing between $35–$45. 

For a comparison of discount brokers, visit the Motley Fool's investing Web site.

Pick Your Stock 

Once you’ve found a broker, it’s time to pick your stock. There are plenty of resources for finding stock recommendations (see our box below), so you may want to start by browsing those sources, or finding out if any of your favorite companies are publicly traded. 

Many brokerage houses give stock ratings of “buy,” “sell,” or “hold,” depending on the value of the stock and the behavior of the market. However, each brokerage house has its own set of standards regarding how these ratings are assigned; some “buy” ratings suggest that a stock will gain 15 percent or more over the next 12 months, while others simply predict that a stock will do better than the overall market. Before you follow ratings, make sure the brokerage’s investing philosophy matches your own.

If you’re using a discount broker, call the Investor Relations department of the company in which you’re interested and ask for company financial records detailing income and past performance. You can also choose stock investments that reflect your social and environmental values. For example, you may want to seek out companies that work on green energy or have great diversity records. Or, you might exclude those tied to human rights abuses or poor environmental impacts from your portfolio. For assistance, you can work with a financial advisor who specializes in socially responsible investing (SRI), as she or he will have access to special SRI databases and screening tools. If you’re using a discount broker, you’re largely on your own when it comes to SRI screening, but the resources below can help you find green stocks. 

Once you become a shareholder, make sure to vote for social and environmental proposals on your annual shareholder proxy ballot. You can find detailed information on being a shareholder activist on our Web site.

Buying and Selling

When you’ve settled on the stock you want to buy, it’s time to make an order. Stocks are most commonly sold in round lots, or lots of 100 shares or more. A lot of less than 100 shares is called an odd lot; odd lot transactions generally have greater commission costs associated with them. Financial professionals advise having enough money to buy a round lot of shares in one company. Many discount brokers require that you trade at least 100 shares of stock at a time.

There are two main types of stock orders.

Buy at market: You order your broker to buy shares at the current market price. 

Buy at limit: You order the broker to buy shares only up to a certain price. If you want to buy 100 shares of a company, but you’re not willing to pay more than $40 a share, your broker will watch and only purchase shares for you when they’re available for $40 or less. However, there’s also no guarantee that the stock will be available at that price, so you might never be able to buy it.

When it’s time to sell your stock, there are a few ways to do it. You can sell at market, in which case your shares will be sold at the prevailing market rate. You can also sell at limit, guaranteeing that your broker will only sell your stock at a specified price or higher.

One way to ensure you won’t lose too much on your investment is to put a stop-loss order on your stock. In this case, you pick a price and make a standing order to sell your stock if the market price drops to your limit. If you bought your stock at $40 a share, you may put a stop-loss order of $20 on the account. When the market price for the stock falls to $20 a share, your stop-loss order will activate, and your broker will sell your shares. 

It’s important to note that placing a stop-loss at a certain price does not guarantee that you’ll get that exact price for your stock; rather, once the market price drops to your limit, your shares will be sold at market price during the next available sale.

Investor Discipline 

Even though you may be investing in a company you believe in, beware of becoming too emotionally attached to a specific stock. Advisors recommend setting a sell limit for yourself when you purchase stock and sticking to it. 

You also want to avoid the pitfall of excessive trading. Online discount brokers make it easier to watch the market and make fast trades, but the fees and commissions can add up quickly.