Most people invest in stocks through either mutual funds or exchange-traded funds (ETFs). That’s usually the right strategy, because picking winning stocks requires both time and knowledge. Unless you work in the investment industry, both are likely to be in short supply.
However, what if you’re heavily invested in funds but are thinking of taking a plunge into individual stocks?
If you’re invested only in funds, branching into stocks can be a real education. Or more to the point, education is what you’ll need to make it work!
Although investing can seem easy when you’re investing in funds, especially in a steadily rising multiyear bull market, picking individual winning stocks is an art form all its own.
For that reason, we’ve compiled this step-by-step guide to buying your first stock. It’s an overview designed for a beginner, and you’ll learn a lot more as you move forward. But there are certain things only real-world experience can teach you. Until then, this guide can help get you started.
Choose an Investment Brokerage
Although the investment brokerage you invest through has nothing to do with the stocks you’ll buy, it’s nonetheless a critical part of the process. You’ll want to go with a firm that offers a combination of low trading fees, strong trading tools and educational resources.
The best choices are the large discount brokerage firms. These companies are mostly household names, charge very low trading fees and have all the resources you need to become a better investor.
Outstanding choices include brokerage firms we’ve reviewed here at Investor Junkie. You can see the whole list of reviewed brokers here. Some of those brokers are:
- Robinhood. This stock broker platform requires no minimum investment and charges zero fees. This is a great choice for beginners, but Robinhood does not currently offer retirement account (IRA) options or extra features some investors prefer.
- Ally Invest. There’s no minimum initial investment, and trading fees are $4.95 per trade. But if you become a frequent trader, these drop to $3.95. The brokerage also has a tie-in with Ally Bank, which offers some of the best savings rates available.
- Charles Schwab. Requires a minimum initial investment of $1,000, and trading fees of $4.95 per trade. Schwab also boasts outstanding customer service and a wealth of trading tools and educational resources.
- Fidelity. The minimum initial investment is $2,500, and this broker also offers commissions at $4.95 per trade. Like Schwab, Fidelity provides full-service trading tools and educational resources, as well as excellent customer service.
- E*TRADE. The minimum initial investment is just $500, although trading fees are a bit higher, at $6.95 per trade.
- TD Ameritrade. Another broker requiring no minimum initial investment. Commissions are $6.95 per trade. TD Ameritrade offers one of the best trading platforms in the industry, as well as excellent research tools.
Choose the investment broker that works best for you, based on your own personal preferences.
Choosing the Stock You Want to Buy
This is the single most important step. You should invest only in stocks you know and understand.
Know both the company and the industry. This includes knowing how long the company’s been in business, the officers and their experience, its future prospects, and its main product or service lines. You should also be familiar with the challenges the company faces.
The company’s product line is critical. The best long-term investments are almost always with companies that enjoy strong brand recognition, brand loyalty and dominant market positions. You shouldn’t select a company based on a product or service that you personally like. It’s more important that it’s a winner with the general public. For example, companies like McDonald’s, Coca-Cola, Starbucks and Apple have proven to be winning investments because of the superior image of their products.
Knowing the industry is about the competition the company faces. You should understand the following:
- Is the company a leader in the field?
- Who are the major competitors, and how strong are they?
- The regulatory environment the industry operates in.
- What are the major challenges facing the industry?
- Is it a growing field (very important!)? Or is it in decline?
Know the financial fundamentals of the company
To do this effectively, you’ll have to learn how to read a financial statement, if you don’t already. That doesn’t mean you have to become an accountant, but you’ll have to know how to extract important investment information. After all, even if a company has a great product, it’s equally important that they maintain sound financial management.
Some important metrics to be aware of include:
- A steady pattern of increasing profitability.
- A steady pattern of increasing revenues, which will indicate the company is growing.
- Earnings per share (EPS) should compare favorably to the general market but more specifically to the company’s competitors.
- Debt: How much does the company have in comparison to its competitors?
- Current debt ratio, which indicates the company’s ability to meet current obligations. It’s calculated by dividing current assets by current liabilities, both of which appear on the balance sheet of the financial statement.
- Dividend growth: If dividends are a major reason for purchasing the stock, you’ll want to know the company has a long history of paying them on a regular basis. You’ll also want to see a steady pattern of increasing the dividend payout.
Decide How Much to Invest
This decision is as important as any other in the stock investing process. You must decide how much risk you want to take investing in a single security.
“Risk” is the operative word. While any security you invest in has the potential to make you a lot of money, you can also lose money on it. That’s an important realization and one that will have an impact on how much you’ll invest.
Stocks are not like bonds, certificates of deposit (CDs), money markets or savings accounts. Anytime you purchase stock, whether individually or in a fund, there’s always the risk of loss. Stocks don’t come with a guarantee of principal, the way fixed-income investments do. You’re investing to make money, but you must always be aware that you could lose it.
The best way to approach the risk factor is to invest no more money than you’re prepared to lose. If $10,000 is all you have to invest, you’ll want to invest only a small percentage of that in any one stock.
Learn the Basics of Stock Trading
Before placing your first trade, you’ll need to learn a few things about stock trading. That should start with basic terminology.
Here are some definitions to familiarize yourself with:
- Bid. This is the highest price a buyer wants to pay for a stock.
- Ask. This is the lowest price a seller is willing to accept for the stock.
- Spread. This is the difference between the bid and ask prices. This may represent revenue to the broker. For example, if the bid on a stock is 25¾ ($25.75) and the ask is lower, at 25½ ($25.50), ¼ (25 cents) is the spread that goes to the broker.
- Market order. This is your authorization for the broker to execute a trade as soon as possible, at the best possible price.
- Limit order. This is an order to purchase a stock at a specific price. The trade will not be executed unless that price has been reached.
- Stop-loss order. This sets a price at which you want to sell a stock if the price drops. In practical terms, it can limit your downside loss. Let’s say you purchase a stock at $100 per share. You decide you’re willing to accept a 25% loss and no more. You set a stop-loss order at $75, and if the price drops to that amount, the stock will be sold without any further action from you. Be aware, though, that if the stock price is dropping quickly, your stock sale may happen at a price lower than the $75 you set. Bascially, when the stock drops to your stop-loss price, your sale becomes a market order (defined above).
There are many more terms related to stock trading, but this list should get you through your first few trades without overwhelming you in the process.
Placing Your First Trade
Once you’ve opened a brokerage account and familiarized yourself with basic trading terms, you’re ready to place your first trade.
A word of caution here: If you’ve never bought a stock before, start by buying stock in a single company. That will give you an opportunity to familiarize yourself with the process. As well, there’s no need to take on the risk of investing in several stocks at once. As a beginner, you’ll want to move into the process gradually, as your portfolio size will allow.
The first step is to fund your account with a sufficient amount of money to make the investment. That should be decided by either how much you’ve chosen to invest in a stock (plus commission) or the minimum initial investment required by the broker. Either way, it will ensure you’ll have the money in your account to make the trade.
Market order vs. limit order. When you place a market order, the price you will pay is subject to movements in the market. If you’re willing to pay $40 for a stock, but it shoots up to $45 on the day you want to make the trade, you’ll need to decide if that works. If your research indicates $40 is a good price, you may want to use a limit order instead of a market order. That will guarantee you’ll pay no more than $40. But just be aware if the price rises, the trade will never go through.
Be especially careful with market orders made after trading hours. If the stock price closes at $40 and you place a market order at 9:30 PM, the stock price could rise to $45 on overnight activity. You’ll be buying it at a higher price than you planned to. A limit order would be the better choice here.
What to Do After You’ve Purchased Your First Stock
This is when patience truly becomes a virtue. If you’ve chosen a strong stock, it will be time to sit back and wait. Once you’ve actually bought a stock, the process can become boring. And that’s not a bad thing. The last thing you want to do is get emotionally attached to your investment to the point that you panic sell if it drops, or buy more at an inflated price after it takes off.
To the best of your ability, you’ll need to take emotion out of the picture. This is where a stop-loss order comes in handy. Let’s say you purchase a stock at $100 per share. You decide you don’t want to risk any more than a 25% loss, so you set a stop loss at $75. Even if the stock crashes, it will automatically be sold when the price hits $75, preventing further losses.
You should also set a target price on the stock. If you purchase it at $100 and decide the price will be excessive at $200, you should be prepared to sell. It’s a surprisingly hard thing to do if a stock price is rising, but it will also lock in your gain. And perhaps more importantly, it will help you avoid holding on to a stock that could become seriously overvalued.
You’ve Heard It Before: Never Put All Your Eggs in One Basket
We’ve already covered moving into individual stocks slowly. But just as important is to make sure that you’re adequately diversified. Given that individual stocks are risky, you should have other assets that will minimize that risk.
Other investments you should include:
- An emergency fund. This account will not only provide you with liquid funds in an emergency, but it will also prevent the need to liquidate your stock positions on short notice.
- A retirement plan. You should have this up and running and being regularly funded. It may even be the account you’re buying your first stock in.
- Fixed-income investments. These will minimize downside risk to your portfolio in a bear market or if your stock picks go sour.
- Funds or a managed account. If you’re new to stock investing, you should have a base of professionally managed stocks. This can be mutual funds, ETFs or a robo advisor account.
What we’re going for here is balance. If you’re new to investing in stocks, holding the majority of your money in the above assets will minimize the impact of making a mistake. As well, these assets can be growing, increasing the overall return on your portfolio.
Final Thoughts on Buying Your First Stock
Not everyone is wired to invest in individual stocks, but a lot of investors should at least give it a try. It may turn out that it’s not for you. But you may also find you have a serious talent for it. And if you do, it can be a way to seriously improve your portfolio returns.
Investing in individual stocks isn’t an either/or situation. For most investors, it’ll be better to have most of your portfolio in funds, managed accounts and fixed-income investments. Have a small slice of your portfolio dedicated to investing in individual stocks. You can increase it as you become more successful, or decrease it if it’s not working for you.
Who knows? You might become the next Warren Buffett. Or you may develop a deeper respect for fund managers and robo advisors.
Either outcome will be a step forward.