How to buy stock
by Kate Williams, Ph.D.
Director of Research
The economy is bouncing back from the recession, which means a lot of people are ready to try their hand at investing in the stock market. But with so many options to choose from, and so much changing day-by-day, buying stocks can feel overwhelming. This guide will help new investors figure out the basics behind finding a broker to work with, how to choose stocks and how to avoid making common mistakes.
I consulted with five experts for this article, including Jason Kelly, investor and author of ten books including “The Neatest Little Guide to Stock Market Investing” (Plume 2012) and “The 3% Signal: The Investing Technique That Will Change Your Life” (Plume 2015).
To get a basic understanding of how the stock market works, I read 11 online articles and read five E-books on the topic, including “Buy Low Sell High: Buying Stocks for Long Term Investing” by DL Williams (2014), “Stocks: Investing and Trading Stocks in the Market. A Beginner’s Guide to the Basics of Stock Trading and Making Money in the Market” by Zachary D. West (2016) and “Invest Like Warren Buffett: Powerful Strategies for Building Wealth” by Matthew R. Kratter (2015).
Who this guide is for
This guide will be useful for anyone who wants to learn more about investing in the stock market. I wrote it with the following audiences in mind:
- Anyone who wants to make more money but doesn’t know how to start investing
- Anyone who is interested in becoming a day trader
- Anyone who wants to know how to avoid making common mistakes when buying and selling stocks
- Anyone interested in buying stocks from certain companies rather than investing in a mutual fund or index
Why buy stocks
Before we delve too far into how to buy stocks, let’s talk about why you should buy stocks in the first place. Stocks can be a great way to grow your money relatively quickly as long as you have done some research and are buying stocks that are expected to grow. “Few investment vehicles can match the growth potential of stocks,” according to West. “There’s almost no reason not to use stocks” to grow your wealth, adds Kelly.
Stocks can also be a way to generate regular income, especially if you invest in companies offering a quarterly dividend. Conservatively investing in stocks over the long-term is one way to reach a long-term financial goal, such as saving for retirement or putting your kids through college.
Day trader versus long-term investor
Some people make a living buying and selling stocks as day traders. These investors buy and sell stocks within the same day, trying to make a profit based on the information available within a 24 hour period. While day traders who really know the stock market and understand what they’re doing can make a lucrative living doing this, “The most successful people that are involved in the stock market do not day trade. The reason why is it is too risky and for most people just does not work,” according to Williams.
In contrast, “the most successful people you have heard of in the stock market are not day traders, but long term investors,” says Williams. Investing long-term allows for stocks to mature and grow, plus you get the benefit of dividends, which you won’t get as a day trader.
Because there is such a difference in the motivation behind day trading and long term stock investing, it’s important to make sure you are reading the right advice for your situation. Following the advice of a day trader when you want to make a long-term investment will most likely end up costing you a lot of money.
How much money do you need to buy stock?
There’s no specific dollar amount that you need to buy stock, as long as you have enough to cover your brokerage fee along with your actual investment. However, there are some financial things that should be taken care of, or at least under control, before you start investing to make sure you don’t end up in serious financial trouble if your stocks take a plunge:
Credit card debts
If you’re having trouble making payments on your credit cards every month, you’re probably better off focusing on paying those down before you start investing in the stock market. Some advice will tell you that you shouldn’t start investing until you have totally paid off all of your credit card debt, but there’s also an argument to be made for starting with small investments that can help you build growth while you continue to pay down your other debt.
If you’re in doubt, talk to your financial advisor. Another exercise, if you don’t have a financial advisor, can be to put aside a certain amount into savings every month for six months, and if you are able to pay your bills without touching those savings, then go ahead and invest it.
Have an alternate savings plan
If your stocks do great, you can pull the cash you’ve earned from them out in the event of an emergency. If they don’t do great, well, they won’t be very useful for you if your car needs an emergency repair. Before investing in stocks, it’s a good idea to have some savings in place for emergencies. Financial experts generally recommend keeping three to six months of bill payments in a separate account before you start investing. If you don’t have this yet, get started today.
Get creative with your savings
You need to spend some time planning for which stocks you are going to buy anyway, so why not spend that time also finding ways to save extra money to invest? Cut out going out to lunch for a month or host a garage sale and put all that extra money into a separate account that you can use to pay your broker and buy stock.
Never put money on the line that you can’t afford to lose
Whether you should have all your credit cards paid off or six months savings in the bank before you invest is debatable and, in the end, a personal decision. The bottom line is you should never put money into the stock market that you can’t afford to lose. The stock market is akin to gambling since it’s risky and includes several variables that are out your control that can make or break your investment.
Common terms defined
Stock is a representation of a stake, or ownership, in a particular company. This means when you own a share (or more) of stock in a company, you become a part-owner of the company. The more shares you own, the more control you have.
Many stocks pay out quarterly or annual dividends, which is the payment a corporation makes to its shareholders. It is generally distributed from the profits made by the corporation. “If a company is paying out dividends it is a strong sign that the company is profitable,” according to Williams.
Price to earnings ratio:
Often shown as P/E, the Price to Earning Ratio is the amount paid for the stock in relation to the profit the stock earns per share. “A high EPS can be a good sign that a company is doing well,” says Williams.
Also referred to as “market capitalization,” market value is the end value you get after you multiply a stock’s outstanding shares by the price of one share. Did I lose you? The calculation is actually pretty simple. For instance, if you’re looking at stocks for a corporation with one million outstanding shares priced at $5 each, the market value is $5 million.
Market value is divided into five categories: Ultra Cap ($25 billion and above), Large Cap ($5 billion to $25 billion), Mid cap ($1 billion to $5 billion), small cap ($250 million to $1 billion) and micro cap ($250 million and below).
“In general, a large cap stock is safer than a small cap stock. However, the latter has better growth and profit potential than the former,” according to West. Basically, what you want to get out of your stock will determine what size cap you go with.
How to start buying stock
You have some money saved and now have a basic idea of the type of stock investment you want to make. Now you just need to get some. There are two ways to buy stocks: through a broker and through a company’s direct stock purchase plan (DSPP). Going through a broker is the traditional way of buying stocks, and it can be a benefit for new investors who want the added bonus of guidance and advice as they start investing.
Here’s a breakdown of what you’ll need to do whether you want to use a broker or buy stock directly from a company.
How to choose a broker:
There are three types of brokers you can work with.
- Full-service: A full-service broker is the most expensive way to buy stocks, but it can be worth the added cost for new investors. These brokers provide guidance, recommendations and advice, which can help you make better investment decisions. If you are not confident in your ability to make good stock buying choices, and/or if you are short on time and want someone to do the research for you, this is a good option.
- In person discount broker: These brokers will meet with you face-to-face, but they don’t provide the added services of recommendations and guidance of full-service brokers. The broker gets paid a commission (usually several cents per share) for handling the buying and selling of your stocks for you. They don’t pick the stocks for you but rather just do what you ask them to do.
- Online broker: Many large firms have online options, and there are also brokerages that operate solely online. One benefit of managing all of your stock trading online is the cost--the commission charged is lower than you would pay for an in-person discount or full-time broker since you aren’t working with a specific individual.
What to do if you want to go through the DSPP:
Going through a company’s DSPP is one way to save money since you don’t need to pay a commission fee to a broker. In general, DSPPs have a minimum deposit requirement ranging from $100-$500. Go with a DSPP if you have a sound investment plan and are looking for an inexpensive way to get into long-term investing and have a good grasp on which companies you want to invest in.
What stocks should you buy?
When it comes down to it, which stocks you choose to buy is a personal decision. You should make your decision based on your own research and knowledge of the company. Here are some general guidelines to help you reach your decision, especially if you are new to investing:
Buy from a company you know and recognize
It’s not a good idea to buy stock from a company you don’t recognize. “Before you invest in a company, you need to understand the products or services that it provides. It is even better if you personally use and love the company’s products or services,” according to Kratter. Understanding a company and how their products work will make it easier for you to put the company’s financial reports into a context you can understand.
Of course, if a company you’re unfamiliar with seems appealing, by all means research it and invest if you want to. Just make sure you really understand the company and the product it’s selling before you give them your money to avoid surprises.
Buy stock in a company with a habitual consumer base
If you want to earn a steady income from a company’s stock, invest in a company whose product is habitual. Examples include coffee and cigarettes, among others. This type of company is more resilient to recessions and other economic hardships because their customers will continue to buy from them while they cut back on other non-necessities.
Invest in a company that’s been around for awhile
Investing in startups can be rewarding, but when you’re just getting your feet wet it’s a better idea to stick to companies that have been around for awhile. You’ll have a solid historical record to research along with the security of dealing with a stable company. You can venture out and buy stock in a newer company down the road once you’ve gotten the hang of investing.
Common mistakes to avoid
You’ll probably make at least a few mistakes when you start buying stocks, which is why it’s important to have money set aside for the sole purpose of investing that you won’t necessarily miss if it’s lost. Here are some common big mistakes to avoid to lower your risk and minimize the chances of losing all your money:
Investing without a purpose
Investing in stocks can be a smart idea, but only if you really understand why you’re investing in the stocks you’ve chosen. Don’t blindly take the advice from your financial advisor or broker without comprehending what you stand to gain from their investment advice. Do you want to invest for income? Or are you trying to get money for a specific goal such as retirement or paying for your child’s college education? Knowing your “why” is just as important as understanding the “how” when it comes to investing in the stock market.
Trying to learn from past mistakes
One thing separating the stock market from other risks is you really can’t learn from your (or anyone’s) past mistakes: “What happened in the past may not happen in the future,” says Kelly. You “can’t build on past knowledge” with stocks the way you can with other types of risks and investments. This is because the stock market represents a particular moment in time. Buying stocks now for a company that did well in the 1980s doesn’t mean you’ll see the same results as you would have 30 years ago. So many factors go into stock prices rising and falling that you really have to go off of the information you have available right now.
Blindly following an investment guru
According to Kelly, a big mistake people make when they’re starting to invest is blindly following the advice of someone the media has decided is an investment guru. The person might be having a good year, or even decade, but their fortune “only lasts until it doesn’t,” says Kelly. And when they make a bad move or a mistake, you, the person who relied on their advice without doing your own research, will suffer a major loss. You need to be responsible for your own stock success by doing research and keeping up with the market.
Buying stock can be a great way to increase your stream of income, especially when you’re focused on long-term investing. Following these strategies, by researching the stock market, choosing companies you know and recognize and investing in companies with a proven track record can add up to wise investment choices. If you’re still unsure about how to start investing in the stock market, or you don’t want to take the time to figure out the best stocks to invest in, consider hiring a full-time broker who can guide you through the process and offer helpful advice based on your desired outcome.
- 8/24/16 Last Updated
- 11 Experts interviewed & consulted
- 16 Articles and books analyzed
- 43 Hours spent doing research
- 90% Found this helpful