The Definitive Guide to Buying Stocks
In this guide I’m going to teach you about buying stocks and how the stock market works. There are thousands of companies who have shares of stock being traded on the stock market.
Ownership of corporations is divided into shares of stock. A public company has many owners and its shares trade on a stock market, providing liquidity for the company’s shares. The stock market determines the price for those shares.
The stock market is an important place to park a portion of your retirement savings if you want to see your nest egg grow over the several years you are working and even during retirement.
Let’s get started with 5 different reasons I think you should invest in stocks.
5 Reasons You Should Invest in Stocks:
- Staying ahead of Inflation
- Tax Advantages
- Historically the Best Investment Choice
- The fun of making purchases with other people’s money
You can’t earn your way to wealth. People who earn millions or win the lottery still end up broke.
You can manage your way to wealth though.
Money management is the true way to wealth and investing is a crucial part of money management. Investing is letting your money work for you.
Currently, you’ll spend many years working hard to EARN money but you’ll also spend it just as fast and be broke if you don’t manage it properly.
Again, you can’t earn your way to wealth but instead must make your money work for you if you want to retire comfortably and at a reasonable age.
Write this down or save it as a quote on your iPhone’s lock screen: “You have to move from a world where you work for money to a world where money works for you.”
2. Staying Ahead of Inflation:
Parking your money in a bank account these days will net you 0% interest basically. Inflation is historically a few percent annually so letting your money sit in a bank account is a sure way to fall behind inflation and have less buying power years down the road. Investing has historically produced 7% annual returns which means you can outperform inflation by 4-5%.
3. Tax Advantages:
The greatest investors in the world understand the importance of tax efficiency. Every time you bring home a paycheck, YOU are the LAST PERSON to get your hands on YOUR own money that you put in the time to work hard for! Before you see your paycheck you have the government taking out:
- Federal Taxes
- State Taxes
- City Taxes
- Social Security
Then you have creditors asking for loan repayments on your car or home mortgage. You have phone service companies asking to be paid, groceries, gas and insurance for your car, utilities for your home and many other people fighting to take your money from you for their services and products.
What’s left after all that? How are you ever going to retire and build wealth if the world is trying to swipe it all away from you before you can ever get your wealth snowball rolling down the hill growing larger and larger?
Understanding Tax Advantages the IRS has made available to you legally as well as investment tools that shield your money from taxes is important to building your financial wealth.
An Individual Retirement Account (IRA) is one way to be tax efficient if you meet certain requirements. The government allows you to pay yourself first by having money withdrawn from your paycheck and placed into your IRA account. This reduces your taxable net income which results in a lesser tax bill. More money stays in your hands and can grow tax free depending on which IRA account you utilize.
You have Roth IRA and Traditional IRA accounts to choose from. One puts after tax income into an account to grow and when withdrawn you don’t pay taxes. The other is pre-tax income placed into an investment account to grow tax free and when you withdraw it at retirement it will finally be taxed. This is huge and here’s a hypothetical example why.
If you double $1 for 20 years you’ll end up with about $1,050,000. That’s tax free keep in mind so once you withdraw you’ll have to pay 33% or whatever on 1 million and end up with 700,000 still. Now assume you pay the 33% taxes each year before your money can double. After 20 years of doubling and taxes you’ll have just $28,000. Talk about wealth killer. Taxes each year slow your progression.
Takeaway: Learn the IRS approved methods for growing your money tax free as it can help you achieve financial independence much much faster. How much are you willing to pay yourself first before anyone else gets to touch your money? Before spending?
4. Historically the Better Investment Choice:
The stock market has been the best investment performance wise over the past 100 years. As mentioned a few times, the stock market returns 7% annually on average which outpaces inflation as well as other investment options such as real estate, bonds, CD’s, etc.
The market goes up and down from year to year but if you put money away for 40 years to grow for retirement then it’s expected that it will grow and you shouldn’t worry about the short term down years. The 2009 stock market crash split many people’s retirement accounts in half or worse but here in 2014 the stock market is hitting all-time highs. The stock market recovers historically and pushes new highs.
Individual stocks can harm your retirement though if you aren’t diversified well enough. Some stocks still haven’t recovered from 2009 but the general market has. You can buy an index fund like $SPY which mirrors the S&P 500 so that your money is diversified among the 500 S&P companies without having to actually buy all 500 and rack up huge commission fees.
5. The Fun of Making Purchases with Other People’s Money:
Another way of thinking you should adopt is that investing allows you to buy what you want but with other people’s money.
For example: Instead of making that $500 TV purchase this year, invest $5,000 or so into the stock market and once your investment is up 10% you can sell and you’ll have made $500 that you can withdraw to go purchase that TV. Then you’ll still have all $5,000 of your money in your account instead of $4,500.
A more extreme example: Instead of making spending purchases in your 20’s and 30’s that you don’t need necessarily, save and invest as much money as possible so that it grows huge and then when you’re in your 40’s and 50’s you can go buy the really nice things you’ve always wanted and still have lots of money left over for traveling and retirement.
Sacrifice now to let your money grow itself and turn into free passive money that you didn’t have to work for. Then go buy what you think you need/want.
Another extreme example: If you can build an investment account to $1 Million over time then you’ll be able to retire and live off the $70,000 to $100,000 that your $1 Million earns you in 7-10% interest each year. Building an account to $1 Million is easier than you may think.
I’ve got an eBook for you to check out on my courses page titled The Book on Stock Market Investing and it will get you up to speed on the basics of the stock market, how to invest, how to create an online account, and if you subscribe to my exclusive email newsletter, you’ll get a free eBook on Millionaire Math showing you the way to think like a millionaire and walks you step by step through some financial calculations you need to do at home with your finances.
How to Set Up a Stock Brokerage Account
Online investment brokerage companies are convenient for people who want to invest their own money. It can save costs compared to paying a financial adviser.
Most financial advisers will charge $40-$60 in commissions and sometimes more if they go by a percentage of funds traded.
Online stock brokers charge $5-$10 in commissions.
Day trader’s certainly benefit from a cost perspective as each trade executed there is a commission the trader must pay. Since day traders are actively making several trades a day or week these commission fees can add up over time so the cheaper the better.
Another benefit to online investment brokerages is the ease of making trades for people wanting to actively manage their money. A simple few clicks of the button can send an order to buy or sell stock and it is executed usually by the time you have refreshed the page. (Scottrade does exceptional at this)
Otherwise through a financial adviser you have to call them and explain what you want them to trade for you and they’ll give their opinion on your stock and it’s a time hassle. This takes longer and if the stock is volatile, meaning price is moving up or down quickly because of lots of trades, then you can miss out on serious gains or incur serious losses.
Financial advisers are great but they are better suited for the retirement investor who wants to buy a few stock to sit on long term and not actively trade stocks. Those looking to day trade and be more active with their investments should use online stock brokers.
Which Online Stock Broker Should I Use?
I get asked this question all the time and to be honest it is up to you. There are several good online brokers so it comes down to your preferences and how picky you are.
Some people just want cheap trades while others look at the brokerage company for other things such as checking accounts, chat rooms, interest earned on your cash balance, etc.
I personally use Scottrade for its cheap trades in order to day trade without incurring lots of fees. I don’t have much interest in the other features of brokerage accounts so I looked for a high quality company that offers cheap trades and keeps the price constant long term.
Some companies will give you low costing trades for up to so many trades and then raise the price.
Here are some online stock brokers compared side by side for you to look at. Links will be posted below.
Links to 4 solid companies:
Main Qualities An Online Broker Should Have
- Low cost
- Beginner Friendly User Interface
Above I mentioned the importance of low cost.
I will note that a friend/investing student of mine uses Fidelity and they only allow 10,000 shares to be purchased for their $7.95 commission fee. This causes problems for people who are trading penny stocks (stocks under $5) and especially those trading stocks under $1. It forces traders to make multiple orders of 10,000 shares costing them a lot in commissions depending on how many thousands of shares they are purchasing.
User interface is important as well because you want a stock broker company that makes it easy for the user to navigate their trading platform.
Scottrade has a Home tab, Trade tab, and My Account tab on the laptop/computer interface making it simple and easy to navigate. Their mobile app is also easy to use and convenient for when I’m away from my laptop.
Along with user interface, it’s important that the stock brokerage has helpful tools and resources. New traders will benefit from this especially until they learn the ropes of investing.
Here is an example of a tool Scottrade offers that I absolutely love. It is a streaming quote tool that allows me to enter the ticker symbol of any stock and then adds it to the list of current stocks I’m watching. The prices are at up to date speeds whereas yahoo finance (which I also use a lot for research) often has a 15 minute lag for the prices of stocks.
This streaming quotes tool flashes red and green cells showing what stock prices just decreased and increased. Red is bad, green is good. Yellow means it hit a new high or low depending which column it lights up in out of the “High” and “Low” columns. Overall, it’s very helpful in seeing the stocks and their price action and volume trading levels.
**Disclaimer- The symbols used in the photo are for educational and example purposes only for illustrating what this streaming quotes tool is like. They do not constitute stock selection advice nor indicate that I have any positions in any of them.
For anyone interested in learning more about online brokerages just leave a comment or question.
If you decide to open an account with Scottrade and would like 3 free trades, then feel free to use my referral code IEGS9352. Free trades are nice to have as commissions add up over time and slow your growth momentum. Therefore, be wary of high frequency trading to avoid racking up the fees. Hope today’s article helped.
In order to find stocks to buy and sell you need to know where to find them right? Well a site that is great for doing stock research is Yahoo Finance. You can access it via the url finance.yahoo.com or by googling Yahoo Finance. I would recommend saving it as a bookmark along the top of your screen for easy click access.
How to Research Stocks to Buy
Yahoo Finance: Home Page
When you arrive on the home page you’ll notice the search bar at the top. This is where you’ll enter ticker symbols of the stock you want to look up.
Underneath the search bar are the 3 major Indexes, the S&P 500, the Dow, and the NASDAQ. This is convenient for monitoring how the overall market is doing for the day. You can see how many points up or down each index has moved, the percent change, and a graph for visual purposes.
To the left, you can see your recent stocks you’ve looked up with another search bar below them. The middle column is general finance news and articles published about the economy or certain stocks.
Once you search a stock like Apple for example you’ll be taken to this page.
Top Header Section:
Starting in the top header you’ll see the company name and ticker as well as its price. Next to the price is the dollar change and percent change on the day. Below you can see “After Hours” which is how the stocks trading after the market closes at 4pm. We can’t trade past 4pm but some institutions can so it affects the stock price post market as well as pre-market trading in the morning before 9:30am.
In the first left side column is the price of the stock at its previous days close. The dollar change and percent change is calculated from the previous close which you can see if you add 1.40 to the 117.60 previous close to get 119.00.
The open is what the stock price was at 9:30am so in this example Apple traded $0.35 higher in the pre-market to open at 117.95 despite it closing at 117.60 the day before.
Bid & Ask:
Bid and Ask are in the vocabulary section but these show what prices people are trying to buy the stock and sell the stock for. Yahoo’s bid and ask aren’t very up to speed compared to your online brokerage platform so you can ignore Yahoo’s bid and ask data. Bid and Ask are important to monitor while trading because they will be constantly changing every second as trades are going through and they occur before the price change occurs so you can get a little edge or idea of how the stocks about to trade in a few seconds. For example, the bid and ask may down tick to 118 and 118.25 from 119 and 119.25 and then a few seconds later you’ll see the price change from 119.10 to a number between the bid and ask such as 118.10. Seeing the bid and ask change gives you a heads up a few seconds prior to the stock price changing of which way the stock is trading.
When you watch the bid and ask in the pre-market going up or down while the stock price doesn’t move because the market hasn’t opened yet, you’ll be able to tell if the stock is going to open up or down from people putting in orders before the market opens. If a lot of people are putting in buy orders then the bid and ask should be greater than the price the stock closed at and you’ll know that at 9:30am when the market opens that the stock will trader higher.
1 Year Target Estimate: What analysts are predicting the stock price to hit. Many stocks are well below or well above these estimates so don’t take them religiously. They don’t mean much as they’re just other people’s predictions based on modeling. Over the long term they may mean something but it just depends.
Beta: How volatile a stock is compared to the market. A beta of 1 means the stock will trade with the market. A beta above 1 means the stock price will trade more volatile/crazy than compared to the market. So the market may be going up slowly a half percent and then a stock with a high beta may be up or down 2-4% one day for example. Volatility is good for day trading but long term investors want more stable stocks that don’t have huge price fluctuations so lower beta’s that are closer to 1 are usually representative of less volatile stocks.
Day’s range and 52 week range show the stock price ranges, pretty self-explanatory.
Volume shows how many shares have been traded so far during the day. Average volume shows you what you should expect the volume to reach by the end of the day but it will always differ. Some days the stock will be traded a lot more than the average volume due to news releases or other catalysts and some days volume will be low. You want to find stocks that have a high average volume of 1 million or more typically. This will ensure liquidity (ease of buying and selling your shares) so that you aren’t stuck with them when you want to get out. Stocks that only exchange a few thousand shares a day will be tough to find buyers or sellers for.
Market Cap shows you the company’s current value based on share price multiplied by the shares outstanding. Companies above a 500 million cap are safer. Companies under 500 million market cap are typically your penny stocks and volatile stocks.
Price to Earnings:
This is just a ratio that is used for comparison to other companies in the same industry. It’s a multiple of how much $1 of a company’s earnings are worth to shareholders. Apple is a technology company so other technology companies similar to Apple will have P/E ratios that will be compared with Apple’s. If the tech industry has an average P/E of 22 for example then in this case Apple’s 18.45 indicates that it may be undervalued. Once Apple’s stock price rises, the 18.45 P/E ratio will increase as well. If the industry P/E average was 14 then Apple’s 18.45 would show that Apple is overvalued possibly compared to the industry as a whole. Some companies may have 200 P/E ratios when the industry average is 15 yet the company isn’t overvalued. It may have earnings coming up that are expected to be amazing and so the price has already adjusted and taken them into account before they are actually reported so the ratio will adjust upon earnings announcement.
Earnings Per Share (EPS):
This ratio is important to investors. It’s calculated by taking net income and dividing by shares outstanding. So in Company X’s case if it has earnings of $1 Million and has 2 Million shares outstanding then EPS would be $0.50. Each quarter when a company reports earnings, it’s EPS will be compared to analysts EPS predictions for the company to see if it beat or missed expectations. An earnings beat results in share price increasing usually and an earnings miss can cause the stock price to fall. Earnings season happens 4 times a year so if you are a day trader and like roulette you can play earnings roulette, purchasing a company you think will be earnings estimates and hope you’re right so your stock price increases.
Since company’s earnings are seasonal and sales differ every quarter, EPS for Q1 of the current year will be compared to the EPS for Q1 of the previous year to see year over year growth for that quarter. The total EPS of all 4 quarters is also calculated and called the annual EPS. It is compared to the previous year’s annual EPS for year over year growth as well. A live example will be shown in the fundamental section coming up shortly.
The Stock Chart/Graph:
The graph to the right of the picture has different time period increments you can click on to view the stock for. Charts will also be discussed shortly but in general you want stocks with clean up-trending graphs.
In this example for Apple, you’re seeing a 1 year graph of Apple’s stock price. You can run a quick calculation estimate of its 1 year share percentage gain to see what you would have made if you invested in Apple a year ago. In this case Apple’s share price increased $40 roughly from $80 to $120. What percent gain is this?
$40 price increase divided by $80 initial share price results in a 50% increase roughly over the past year. So if Investor Rich had put his $5,000 into Apple he would have made $2,500 if he sold a year later at the time of this photo.
The stock market is full of a lot of woulda, shoulda, coulda unfortunately.
When calculating gains and losses, don’t get caught up in the number of shares. Instead it’s a quicker calculation when you worry about Percent Change and then multiply your Investment Total by the Percent Change to calculate profit and loss totals when doing quick math.
Example: If Apple’s current price happens to be $110 and I see on the chart its all-time high was $120, I already am thinking $10 increase to get back to that high is going to be roughly a 10% increase in my money if I buy Apple at $110 and hold until $120. That $10 share price increase divided by the cost at $110 is roughly 10% when doing quick math.
Then I take that 10% gain and multiply it by my $1,000 investment for example to get a $100 potential profit.
The slower and more accurate calculation method would be to use a calculator to divide your investment by Apple’s price to get your number of shares and then multiply them by the dollar increase of the price. Quick math is usually easier and commonly used by day traders trying to make quick decisions on whether a stock’s chart has potential or not.
What I just did with Apple’s share price was also known as Technical Analysis, basing my investment reasoning on price action and charts.
You can read more on technical and fundamental analysis in my other articles as well as future articles by visiting the stock market section.
Stock Market Reporting: Stock Quotes
As a common stock owner, you have rights to any common dividends and since you have a share of ownership in the company, you also get a share of the rights to vote on the election of directors, mergers, and other major events that occur within the company.
A ticker symbol is an abbreviation that each company gets when they join the public stock market. For example, Apple’s ticker is AAPL, Google is GOOG, Nike is NKE, and Disney is DIS.
Shares on the New York Stock Exchange (NYSE) typically have 3 symbols or fewer and shares of companies on the NASDAQ typically have 4 or more characters. But companies like Facebook and Twitter have shown that this rule no longer applies as their respective tickers are FB (NASDAQ) and TWTR (NYSE).
Companies are valued by their share price multiplied with the number of shares outstanding. For example a company with a share price of $50 and 1,000,000,000 shares would have a market valuation (also called market capitalization or “market cap”) of $50 Billion. This is the total value of all the equity of a company. As the company’s share price increases, so should their equity value.
Other metrics to analyze companies include the price to earnings ratio and the earnings per share ratio.
Price to Earnings would take the market value of the company ($50 Billion in our example) and divide it by company earnings for the year which we will make up in this example as $2.5 Billion. Dividing 50/2.5 yields a 20 Price to Earnings ratio meaning shareholders are willing to pay 20x the company earnings for a share of the stock. As the price of stock increases, so will its price to earnings ratio. As earnings increase, the P/E ratio will decrease.
Earnings per share is a metric used to compare earnings performance from quarter to quarter and year to year. The company in our example had earnings of $2.5 billion and had 1 billion shares, so we divide $2,500,000,000/1,000,000,000 and get a $2.50 earnings per share. If a company increases earnings, the earnings per share will increase and their Price to Earnings ratio will decrease because earnings is on the denominator of the P/E equation.
Now that you know the earnings per share and the price to earnings multiple you can multiply the two in order to calculate the share price:
- $2.50/share x 20 price to earnings = $50 share price (same as discussed in above paragraph)
As companies grow and increase earnings, their share price should increase as well to reflect this change in P/E ratio and increase in EPS. If the P/E ratio drops from 20 to 16, investors are willing to pay more for the stock until the P/E ratio climbs back to the usual range or industry P/E range.
What About Dividends
In regards to dividends, most companies pay out dividends quarterly which means 4 payouts per year.
If a company pays out a dividend of $0.50 each quarter and their share price is $50.00 then it is paying out a 4% dividend yield ($2.00/$50.00).
You can see on this chart of the company Wal-Mart the different metrics discussed above as well as the dividend yield. The Market Cap, P/E, EPS (earnings per share), and dividend yield are all next to each other making it easy for you to find and check.
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