How to Buy Stocks

While it may seem mysterious in some ways, investing in the stock market is really not that difficult.  This is not to say that beating the market is easy, or that every stock pick will result in making money.  Compared to things like real estate, however, it is fairly easy to learn the mechanics of stock investing, and the risks of poor stock choices are generally limited to the amount put into it (compared to the hundreds of thousands that could be lost when investing in real estate with mortgages).

The first thing to understand is that when investing in individual stocks, you could lose the entire amount very quickly.  This is not to say that it is likely to happen (out of 100 stocks, you may have 2 or 3 that lose 90% or more of their value and will never come back).  The point is that you should never put more into a single position than you are able to lose, because things do happen, even to what seem like solid companies.  For example, GE, Freddie Mac, and GM shareholders all lost most or all of their money in 2008. 

The main way of countering the risk of issues at a single company (or a sector of the market) causing a substantial loss is to spread the money out to a basket of stocks – what investment managers call “diversification.”  When starting out it is unlikely that you will have enough money to buy 10 different stocks (or 100 different stocks) as the financial magazines suggest.  There is nothing wrong with buying 100 shares of one stock with your first $2000 say.  Just understand that you could lose that $2000 and it should be thought of as an initial step into the market.  To really make money int he stock market you should plan to be acquiring shares over a number of years.  You should be putting money away regularly and each time you have $2000-$3000, buy another 100 share of stock.  Over time you will build up a portfolio of several stocks this way.

Now that the strategy has been laid out, what about the mechanics?

Stocks are purchased using a broker.  Finding a broker is fairly easy – some of the popular choices are Merrill Lynch, E-Trade, Charles Schwab, UBS, and Fidelity.   Like finding a doctor, the best process is to ask a friend or coworker for a recommendation.  Taking time to meet with the broker, discuss your financial goals and get a general feeling about their personality would be a good idea.  In general one would want to find an individual who will be willing to teach you about investing, rather than just sell you products.  A good place to start is the Endorsed Local Providers list at the Dave Ramsey website, https://www.daveramsey.com/elp/investing/    .  Once a broker is selected, an account is set up. and funded.

Once an account is set up, there is nothing left but selecting a stock and placing an order.  The process of selecting a stock is described in various posts on this blog http://smallivy.wordpress.com/category/stock-picking/.  Traditionally individual would enter orders to their broker via phone (or some would hang out at the brokers offices).  Entering orders by phone is probably the best option for a new investor, although there are also a number of online brokers who allow individuals to enter trades via computer.  The advantage of this is that the cost of commissions tends to be lower.  The disadvantage is that there is typically little guidance (if you enter an order on the phone, the broker may point out a better way to enter the trade or a better choice of stocks).

Once the first position is established, just continue to save up money and invest. 

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Your Investment Questions Please

I’ve now covered most of the topics I was looking to cover and I think there is a pretty good set of information on the blog.  I can continue on and expand, but I thought it there might be some questions out there.  Please use the Comments selection to let me know what’s on your mind. 

Small Ivy

Financial Asset Management in Stock Investing – Balancing Risk and Return

An important concept to understand in investing is risk and return, often expressed as a risk/reward ratio.  The basic idea is that the risk/reward ratio should be about the same for any investment.  If an investor is taking more risk, he should expect to have the chance to get a greater return on his investment.

For example, a bank account is a fairly risk-free investment.  Because losses in banks is very rare — even rarer since the Government began insuring bank accounts and requiring that banks hold a certain amount of capital in reserve — the amount of return from a bank account is fairly low.  Bank investors do not expect a large return from their bank accounts as long as they can reasonably expect to be able to get the money back when they need it.  The return is actually a little worse than inflation in fact, so wise investors only keep as much in savings accounts as they may need in the near future.

Investing in common stocks carries a bit more risk.  There is always a chance that a company’s business strategy may not work, or that someone in a company may make a big mistake, or that the company will get sued, causing a large loss.  Even if nothing big happens, company earnings may not grow as expected and the share price may stagnate, resulting in an opportunity cost — money invested in a company that goes nowhere instead of another stock that grows.  For these reasons investors will not put money into stocks unless there is an opportunity to make significantly better returns than in a bank account.  Because stocks have historically had better returns than bank accounts, investors have continued to put money into stocks.

As said at the start of this post, the risk/reward ratio for different investments tends to be nearly constant.  For example, if the risk of investing in a bank account is 1 (some arbitrary unit), and it’s return is 2%, such that the risk/reward ratio is 1/2 = 0.5, then if a common stock investment is five times as risky as the bank account, one should not invest in the stock unless the potential rate of return is at least five times as much.  The risk/reward ratio would then be 5/10 = 0.5. 

The pricing of common stocks tends to reflect this.  If bank account yields increase, the price of common stocks would tend to fall.  Because the return from a bank account is now higher, the potential return from common stocks must also be greater, so investors bid down the price until the ratio of the current price to the expected price in the near future is sufficient to account for the risk.

When choosing whether or not to make an investment, the potential reward should be taken into account.  This is the reason to avoid day trading.  In day trading, investors buy stocks for short periods of time, often selling if very small gains (1/8 point or less) are made.  The chance of a trade going the investor’s way over a short period of time, however, is about 50-50, so the chance of losing money is equal to the chance of making money. 

 Since the potential gains are very small, because positions are closed when small gains are made, the rewards are very limited.  The risks are substantially greater than investing in a bank account, however.  Therefore, the risk/reward ratio of day trading is not sufficient.  Over time, one would do much better just leaving his money in the bank.

The strategy proposed by this blog– investing in carefully selected common stocks and holding for long periods of time–certainly carries more risk than investing in a bank account.  Risk is reduced, however, by the careful selection of stocks (companies that have successful business models and should be expected to continue to grow) and the long-term horizon (so that the effects of market distortions do not matter).  In addition, the profit potential is substantial.  Long term investments of a few thousand dollars have turned into millions of dollars for companies such as Microsoft and Walmart.  For this reason, the risk/reward ratio is very favorable. 

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Questions, Comments, and Subscriptions

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Also, if you have questions or topics you’d like me to address in a future post, leave it in a comment and I’ll get to it.  If I’m boring you with some topics, let me know that too.  I’m trying to help both beginers and more seasoned investors, so use the categories to find the topics that interest you.

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Best Regards,

Small Ivy

An Expensive Lesson

Back in the early 2000′s I purchased shares of ITWO Technologies for about $4/share.  (If you’ve never heard of the company, there is a reason).   I purchased a few hundred shares, and then watched as the company climbed steadily over then next several months, eventually topping $20/share. 

Sitting in the airport one day, I was reading the annual report.  I came to the realization that the company actually produced nothing - the entire company was based on fluff and hype.  I phoned my broker and put in a limit order, GTC.  The stock sold off a bit that day, missing my limit.  I sat firm on my limit, expecting the stock to rebound and hit it later.  The stock never did, falling steadily.  I can’t remember if I ended up making a profit on the stock or not, but I’m sure I sold it for $8 or less.

The lesson here is, if you have a reason to sell a stock, don’t play games.  Just put in a market order and sell it.  Likewise, if you have a phenomenal stock, just buy it.  Trying to get fractions of a point may end up costing far more.

Refer a friend – link to this page: http://smallivy.wordpress.com

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.