Saturday, June 4, 2011

How To Buy Stocks?

I've talked a lot about why you should invest in stocks, especially if you are looking over a long time horizon, but you may not know too much about the process.  There are a couple ways to actually purchase stock, but I will mainly look at the primary method for most ordinary investors: a stock broker.

The two types of stock brokers are full-service brokers and discount brokers.  I am personally most familiar with discount brokers, but I will mention what I do know about full-service.  Full service brokers often charge a higher premium for their work and generally offer more in terms of research, financial advice, retirement planning, tax tips, etc.  Full service brokers include Edward Jones, Goldman Sachs, and Merrill Lynch.

Discount brokers, on the other hand, charge a much cheaper commission and offer a much simpler product.  The most important difference is the price: discount brokers are usually around 1/20th the cost of full-service brokers.  This makes them much more attractive for investors who do not want full financial planning service and instead want to just put some money into stocks, bonds, etc.  Discount brokers include TradeKing, Zecco, Optionshouse, Fidelity, and Scottrade.

So what do you pay brokers?  Brokers earn what is called a commission on the transactions they perform.  Some of them are flat fee (you pay X dollars to buy or sell any amount of stock) or variable (you play X cents per share you buy or sell).  Sometimes, commissions take a little bit of both to calculate (such as when buying or selling penny stocks, some brokers charge their normal flat commission and an extra variable commission per share traded).

I currently use TradeKing so I'll use them as an example.  Tradeking has a $4.95 flat commission rate for stocks.  In the fine print, they also add $0.01 per share for stock worth less than $1, but in most instances you won't have to worry about it, especially if you follow my advice and focus more on large-cap companies.  If you wanted to buy about $1300 of the S&P 500, you can place an order for 10 shares of SPY, the ETF tracking the S&P 500.  This would cost a flat $4.95.  Let's say the market moves up over the course of a year and you decide to sell half of your shares (hopefully you keep your money in longer than a year though); it would cost another flat $4.95.  When you want to sell your final 5 shares, it would cost another $4.95.  You can see how these small commissions can add up, so it may be worth it to find the cheapest one.

I will give a formal review of TradeKing later, along with a referral bonus they have for both referrers and referred investors.  To give some idea about how commissions compare though, Scottrade has a flat $7 commission and $9.99 for E-trade.  These are all online trades.  Broker-assisted trades (when you call in and have your broker make the trade for you) usually cost quite a bit more (although TradeKing keeps their flat rate).  I will go over how you make an online trade in a later post, however, so broker-assisted trades should not be a concern.

It may seem like a black box, but essentially when you place an order online, you are communicating through a network that you would like to purchase (or sell) shares of a stock. When a seller (or buyer) comes and matches your price, the trade transacts.  For this service, you pay your broker commission.  You can probably see how these commissions make smaller purchases of stock infeasible (you don't want to spend $5 to buy $10 worth of stock, for example).  There is a cheaper method called direct stock purchase plans which I will discuss later on as well, so be on the lookout for those.

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