I know many readers of Financial Freedom are old hands at the stock market, but the investing world is changing. I also realize that every day, we are welcoming brand-new investors to our pages. And we’re also finding that many subscribers to my two new newsletters, Wall Street’s Best Stocks and Wall Street’s Best ETFs, are also fairly new to the investing world.
I’m thrilled to be able to serve you all and to be your guide to greater investing success.
At first glance, experienced subscribers may think this article may not apply to you, but I hope you’ll continue reading. Services offered at brokerage firms change almost as quickly as the market’s sentiment, and you may find your current company isn’t offering you the extent of products that other competitive firms have, and they may also be charging you more for their services. I’m sure you’ll agree that even if you love your broker, you want to make sure you are taking advantage of all that firm has to offer, and at a fair price. So, by reading further, you may just be able to negotiate a better deal! That’s one purpose for this article.
My primary goals are to make it easier for investors to:
- Research and find a brokerage firm.
- Understand that there are different ways to buy stocks.
- Know how to set up your stock purchases to mitigate your risk and maximize your profits.
That sounds like a lot, doesn’t it? Well, we better get started then.
Step 1: What services and products do you need from your brokerage firm?
Now, I know some of you are going to be stock traders, not investors. But that’s a subject for another article, and while both investors and traders will have some of the same requirements for a brokerage firm, your technology and research needs will greatly differ.
Newer investors will most likely need:
- Educational resources
- Easily accessible help via chat, phone calls, or FAQ’s (frequently asked questions), and make sure that advice is FREE.
Some of you may want to practice before you begin buying and selling, and many brokerage firms will allow you to access online tools and set up “watch lists” for that purpose.
As you become more experienced—and confident—you will also want to seek analyst and other professional opinions on particular stocks, as well as the ability to view fundamental and technical data on each equity.
If you don’t want to buy and sell individual stocks but are interested in knowing more about better managing your 401(k) or other retirement accounts or buying mutual funds and ETFs (Exchange Traded Funds), you will still find many parts of this article helpful.
Lastly, I always believe goals are essential. Think about that for a moment. Do you have both long- and short-term investing goals? If so, your strategies for attaining those separate goals may differ, so keep that in mind as we proceed.
Step 2: Make sure you are dealing with a reputable broker.
You will want to make sure your brokerage firm is a member of the Securities Investor Protection Corporation (SIPC). The SIPC (sipc.org) is a federally mandated, non-profit, member-funded, United States corporation created under the Securities Investor Protection Act of 1970 that mandates membership of most US-registered broker-dealers. SIPC protects the securities and cash in your brokerage account up to $500,000. The $500,000 protection includes up to $250,000 protection for cash in your account to buy securities. This protection does not cover regular trading losses but covers fraud on the part of your broker or brokerage firm and protects your assets should the firm fail.
It would also be prudent to ask your firm if it has additional insurance—above and beyond the SIPC coverage.
Next, you need to ask if the brokerage is a member of the Financial Industry Regulatory Authority (FINRA). FINRA (finra.org) is a private American corporation that acts as a self-regulatory organization which regulates more than 624,000 member brokerage firms as well as exchange markets.
If the brokerage offers checking or savings accounts, or any other deposit products, are the accounts covered by the Federal Deposit Insurance Corporation (FDIC)? The FDIC (fdic.gov) provides deposit insurance to depositors in U.S. depository institutions. It is important to note that investment products—stocks, bonds, options, annuities, and retirement accounts—are not eligible for FDIC insurance. The insurance just covers CDs, Money Market Deposit Accounts, checking, or savings accounts, that you own through your brokerage firm.
Will your brokerage firm reimburse you for fraudulent losses? And what kind of documentation do you need to maintain to prove such losses?
Look up your broker’s record at the Securities & Exchange Commission (SEC): (sec.gov/litigations/sec-action-look-up). This site allows you to look up individuals who have been named as defendants in SEC federal court actions or respondents in SEC administrative proceedings.
How secure is your brokerage firm’s website? Does it offer two-factor authentication?
Step 3: What products and services does the brokerage firm offer?
Here are some of the most common services offered:
- Buying and selling stocks, options, mutual funds, and ETFs
- Individual and/or Business Retirement accounts: IRAs, 401(k)s, SEPs
- Educational Savings Accounts
- Watch lists/alerts
- Stock screeners
- Specific types of orders, including market, limit, stop, and trailing stops, good for day, good until canceled, all or none (more to come on these in a minute)
- Buying on margin (more on that later, too)
Step 4: Determine the fees for the types of accounts and services you want.
These may include:
- Commissions: are these tiered according to account balances or number of monthly trades? Do they differ depending on the type of investment you purchase?
- Account management/portfolio fees (sometimes called advisory fees). It’s usual for these fees to run 1%-2% of your net assets
- Fees for opening/closing accounts
- Deposit minimums
- Maintenance minimums
- Annual/monthly maintenance fees
- Margin interest rates
- ETF/Fund loads, expenses, other fees
Step 5: Is a discount or a full-service broker right for you?
If you think you need advisory services, such as financial and retirement planning as well as tax and investment advice, a full-service broker may be the way to go. However, you should understand that their fees will be higher.
Many discount brokers will offer some sort of advisory service and they generally have low commission rates on trades and are very web friendly.
Additional Questions to Ask:
Are quotes in real-time? Are they streaming? Sometimes, stock quotes are delayed 20 or more minutes.
Can you trade in Extended Hours? That is, can you trade beyond the normal exchange hours of 9:30 a.m. – 4 p.m. EST?
Does the site offer charting capabilities? For new investors, this won’t be of prime importance, but as you gain more experience, you may want to delve into the world of technical indicators, so it would be good to know at the outset of your brokerage relationship if it can offer you more advanced tools.
Is the site easy to navigate?
Is it easy to deposit, withdraw, and transfer funds on the site? How long does it take for these items to be credited to your account?
How long does it take for settlement after you place your orders?
Step 6: Which brokerage firm is right for you?
A big part of investing is knowing your costs. Here are some average costs for making stock trades:
- Stock Trade Fee (per trade): $0.00 – $6.95
- Stock Trade Fee (per share): $0.006 – $0.01
- Broker-Assisted Trade Fee: $0.00 – $50.00
- Mutual Fund Trade Fee: $0.00 – $50.00
In today’s world, it is pretty common for zero commissions on regular stock trades, with fees charged for things like options.
But there is much more to consider, besides fees, such as your experience, goals, frequency of trades, and the type of investments you want to buy and sell.
I’ve reviewed several articles that rank brokerage firms, depending on your goals. Here, I’ve combined information from Investopedia, Motley Fool, and Bankrate.com.
Large Brokerage Firms
|Brokerage Firm||Best For||Account Minimum ($)||Commissions||Web Site|
|Fidelity Investments||Overall||0||$0 for stock/ETF trades, $0 plus $0.65/contract for options trade||fidelity.com|
|TD Ameritrade||Beginners/Mobile||0||Free stock, ETF, and per-leg options trading commissions in the U.S., as of October 3rd, 2019. $0.65 per options contract||tdameritrade.com|
|Charles Schwab||ETFs||0||Free stock, ETF trading, $0.65 per options contract||schwab.com|
|E*Trade||Ease of trading experience||0||No commission for stock/ETF trades. Options are $0.50-$0.65 per contract, depending on trading volume||us.etrade.com|
|Merrill Edge||Customer service||0||$0 per stock trade. Options trades $0 per leg plus $0.65 per contract||merrilledge.com|
|Robinhood||Commission-free, mobile app, cash management||0||$0 for stocks, ETFs, and options||robinhood.com|
|Interactive Brokers||Advanced traders, international trading||0||Maximum $0.005 per share for Pro platform or 1% of trade value, $0 for IBKR Lite||interactivebrokers.com|
|tastyworks||Options, low costs||0||$0 stock trades, $1.00 to open options trades $0 to close||tastyworks.com|
Step 7: How to buy a stock.
First, of course, you need to decide how much you want to invest in a particular stock, mutual fund, or ETF. That depends entirely on your personal circumstances, risk profile, and how long you intend to keep the investment. But for new investors, consider starting small to keep your risk minimal. Most brokerage firms will allow you to purchase one share of stock or an ETF. As for mutual funds, those will typically have minimum investments of around $1,000, although many brokerage firms that offer their own funds have much lower initial minimums.
There are a several ways to buy stocks:
- Through a regular brokerage
- Through a Dividend Reinvesting Plan
- Through the purchase of fractional shares
Buying through Your Brokerage:
You can purchase stocks using different types of orders. They include:
Market order: You ask to buy or sell a stock ASAP at the best available price. Your order will be executed immediately. This is the type of order that most ‘buy-and-hold’ investors use.
Limit order: You ask to buy or sell a stock only at a specific price or better. For example, if the stock you want to buy is trading at $25 a share, and you want to buy it only if it goes down to $20, you would place a limit order. Alternatively, if you want to sell a stock only if it rises to a higher level, you tell your broker that you want to sell it at that particular price. Limit orders are placed after Market orders, and are first-come, first-served, meaning your entire order may not be filled. These orders work well when buying more volatile stocks.
Stop (or stop-loss) order: A market order is placed when a stock reaches a certain price—the ‘stop price’ or ‘stop level’—and the entire order is filled at the prevailing price. Note that this is not the same as placing a stop-loss on your stocks to mitigate losses. More on that in a minute.
All or none order (AON): This order is only placed when all the shares you want to trade are available at your price limit.
Good for day (GFD): This order expires at the end of the trading day, whether or not it’s been fully filled.
Good till canceled (GTC): This order stays in place until you cancel it, or it expires, which could is typically 30-90 days, although could be longer depending on your broker.
You can also buy stocks through your brokerage on margin. That means you borrow the money from your broker to buy the stock (I recommend this only for very experienced investors). Buying on margin allows you to use your brokerage firm’s money to buy shares, so that you can invest more than if you were just using your own money. But it’s going to cost you, anywhere from 1.6%-8% interest.
The Federal Reserve says that you have to put up at least 50% of the cost of your shares in cash (the initial margin requirement)—before you buy on margin. And FINRA requires that you keep a maintenance margin of 25% equity in your margin stocks, at all times. Brokerage firms are also free to set more restrictive margin requirements, which is most likely on volatile securities.
That’s because if the shares decline in price (rather than the increase you were counting on), the broker will place a margin call on you, and you will have to either liquidate your investment or put up more money.
Margin buying is not for the faint hearted. That’s why I don’t recommend it for beginning investors.
Dividend reinvesting is like ‘free money’! And often, companies increase their dividends, which puts even more money in your pocket. And while 2020 was a challenge for most sectors due to the coronavirus pandemic, you can see by this graph that several industries actually increased their dividends last year.
Change in Average Dividend (by sector)
According to DividendInvestor.com, more than 4,100 companies and closed-end funds offer Dividend Reinvestment Plans (DRIPs). A DRIP allows you to automatically reinvest cash dividends by purchasing additional shares or fractional shares on the dividend payment date.
Companies who operate their own DRIPs will often let you buy additional shares of their stock commission-free, and sometimes even at a discount to the current share price. In my Wall Street’s Best Digest newsletter, I follow two investment pros who keep a close eye on dividend reinvestment plans—Charles A. Carlson, editor of DRIP Investor and Vita Nelson, editor of DirectInvesting.com. Each month, they offer great insight into the DRIP industry, as well as a selection of recommended stocks.
DRIPs are often recommended for long-term investors. Buying and selling shares in a DRIP is not as easy as picking up the phone and calling your broker. Most companies buy and sell shares in a DRIP in bulk (to reduce transaction fees), so you are most likely not going to get current market prices. It may take a few days to get in or out, so if you tend to trade stocks, a DRIP would not be your best investing vehicle.
But DRIPs are a great way to invest in well-managed, financially stable companies—for the long term. When my nieces and nephew were born, I set up DRIPs for them, buying stock in McDonald’s. They didn’t get rich from the DRIP, but when they set off for college, they had a tidy little sum to use for buying some of the extras they needed. My hope was that discussing their shares with them through the years would turn them on to investing for life. Alas, that didn’t exactly happen. However, I can report that they were thrilled with the McDonald’s coupons that came with the annual company report each year!
Buying Fractional Shares:
When stocks are trading at what are seen as lofty prices, investors often hesitate to buy them—either because they can’t afford that much money, or because the price is just intimidating.
For instance, as I write this, Amazon (AMZN) is trading at $3,124.51; Alphabet (GOOG), at $2,069.94; and Berkshire Hathaway Inc. (BRK-A), at $377,758.88! That would take a lot of dough to have a portfolio of these companies, wouldn’t it?
That’s why buying in fractional shares is so exciting. Fractional investing—buying pieces of one full share of a company or Exchange Traded Fund (ETF)—makes buying shares in companies like these easy. And they are a great way for beginning investors to jumpstart their investing plans.
Fractional investing allows you to allocate however much money you want to invest among a number of different stocks. And that leads to a much more diversified portfolio than if you invested your entire nest egg in one company’s stock (not counting how unwise that would be!).
According to nerdwallet.com, here are some brokerage companies that offer fractional investing:
Companies Offering Fractional Investing
|Interactive Brokers||All stocks listed on U.S. exchanges|
|Robinhood||Stocks and ETFs worth more than $1 per share; market cap above $25 million|
|Fidelity||Any stock or ETF listed on the National Market System (NYSE, Nasdaq, etc.) — more than 7,000 in total|
|Charles Schwab||Stocks included in the S&P 500 index|
|SoFi Active Investing||Limited to select stocks and ETFs (currently 43 choices)|
|Stash*||Select individual stocks and ETFs|
Of course, there are also downsides to fractional investing, including:
- If you decide to change brokerage firms, you won’t be able to move fractional shares; you’ll have to sell them.
- If you own a very small fraction of a share, your broker may keep your dividend.
- Because it’s so easy, you may be too tempted to buy without doing your research; Please do not do that!
Step 8: Maximizing your gains and minimizing your losses.
My philosophy is this—if you are going to invest, your goal should be to make as much money as you can, according to your risk profile.
Since I like to plan, I want to determine—the day I purchase a stock—just how much money I think I can make from it. And that’s why I set price targets. You should know that there are plenty of advisors who will disagree with me, but setting price targets helps me become a more disciplined investor. After all, if you don’t set a target, how do you know when you should sell a stock?
Setting Price Targets
I recommend you set a price target the day you purchase your stocks. Your target should be based on the P/E of your stock, multiplied out by expected future earnings. I recommend that you at least think about what price your stock can achieve within 18-24 months. And that should at least be a 30%-50% gain. If it doesn’t have that potential, keep looking.
Going forward, when the stock hits your target, reevaluate it and determine if it has the ability to continue double-digit price gains or if you would gain more by cashing in now and using those funds to purchase a different stock with more potential. Many of the contributors to my Wall Street’s Best Digest newsletter make this decision easy for you, by providing targets for their recommendations, and often cash in just a portion of the holding to take some profits and let the remaining shares ride toward a new target.
When I speak at Money Shows across the country, I am frequently asked about how I set my target prices. If it’s not the most common question I get, it’s certainly up there in the top five.
First of all, I can’t emphasize too strongly that it is essential to set a target at the time you buy a stock. If you don’t, then how the heck do you know when your stock has appreciated enough to sell it?
I always ask my workshop attendees how many set price targets on their stocks, and I never see more than two or three hands go up. That’s a shame, but I think it’s because folks just don’t know how to set targets, rather than them not wanting to. So, let me tell you how I do it, but keep in mind that, like all investing, it is not black and white. It’s a combination of science, art, and experience. But most of all, it’s easy! No complicated math here—just a few assumptions.
Let’s walk through an example step-by-step. For this example’s sake, we’ll set your holding period at three years, max.
You’ve done your research and have selected the stock you want to buy—the Widget Co. The price of the stock is $10 per share, the company made $2.00 per share in the last four quarters, so its price-earnings ratio (P/E) is 10 divided by 2, or 5.
The company’s earnings have been increasing at a 20% annual growth rate for the past five years. With a little calculation, you can project out over the next three years, and if that same growth rate continues, the company’s earnings will look like this:
Year 1: 2.00 x a 20% increase = $2.40 per share
Year 2: 2.40 x a 20% increase = $2.88 per share
Year 3: 2.88 x a 20% increase = $3.46 per share
So, at year 3, your company is earning $3.46 per share. Now, if its P/E ratio remains the same (5), the projected price of the shares can be found by mere substitution into the P/E equation, and solving for P:
P divided by E (3.46) = 5. So, a little algebra later, P = $17.30. Wow—that’s a 73% gain! Most investors would be tickled pink by that.
However, should you believe that the company’s earnings may grow even faster than 20% annually, due to some event such as a tremendous new product, gains in market share, new markets, etc., or that one of those occurrences might drive the company’s price higher than $17.30 (even without the requisite earnings growth), you would be even happier.
To be on the safe side, it’s also smart to calculate what would happen should the Widget Co. not grow as quickly over the next three years as it had done for the past three.
The other side of the buying and selling equation is minimizing your losses. And that’s why I set stop-losses.
Stop-losses are a form of protecting your investment.
In addition to setting a price target, I also recommend that you set a stop-loss limit the day you purchase your stocks. For aggressive investors, the stop-loss could be 30% or more. For more conservative investors, you might be happier with a stop-loss of 10%. The actual percentage is not as important as being disciplined in exercising the stop-losses. Sure, no one likes to lose money, but a stock riding momentum down can clean you out in no time, so it’s best to take your losses. If the stock bounces back, you can always buy back into it. Many of our advisors provide stop-losses for you, but it’s always a good idea to consider your own investing strategies when setting your stop-losses.
A stop-loss is simply an order—either formally placed with your broker—or a “mental” reminder—to sell your stock when it reaches a certain price threshold.
It’s painless to place when you buy your stock through your broker’s website, or, if you prefer, you can just set an alert on whatever portfolio tracking web site you use, so that if the stock reaches that price, you can make an instant decision on whether to cut it loose or keep it. That’s what I call a “mental” stop.
I’m a big believer in stop-losses for one simple reason: If your stock doesn’t go the way you think it will (up in most cases!)—for whatever reason—this little tool will limit your potential losses.
Sure, it’s true that if you are diligent in the use of stop-loss orders, you can be stopped out of what could turn out to be a very good stock. But you know what? You can always get back in, and more importantly—stop-losses can also save you money—as well as lots of sleepless nights—if market or industry forces cause your stock to take a nose-dive.
The actual percentage you set is up to you, according to your personal risk tolerance. In my Wall Street’s Best Stocks newsletter, I set both price targets and stop-losses for each recommendation I make, but really, it is up to you. Very conservative investors may want to place their stops at a level that is 10%-15% below their purchase prices. Moderate risk takers would probably feel most comfortable setting stop losses at 15%-25% below their buy prices and Aggressive investors who have a longer time frame and the ability to weather short-term losses, may prefer to set stop-losses at 25%-35% of their purchase prices. To easily determine your risk tolerance, take my Investor Profile Survey.
Here’s how it works: If you buy a stock at $3.00, and use a 20% stop, you would be stopped out at $2.40 (20% or $0.60 less, in this case, than you paid for it).
In normal times, I often find that a 20% stop is sufficient for most stocks; up to 35% if the company operates in a fairly volatile industry.
But in a bull market, you may want to use trailing stops—stop-losses that continue to move up as your stock rises—rather than stops based on the absolute value of your purchase price. A trailing stop is more flexible than an absolute stop, as it continues to allow you to protect your portfolio in case the price of your stock declines. But as the price rises, the trailing stop is based on the new price, helping you to lock in your gains and reduce your overall risk.
It works this way: Using the above scenario. You buy a stock at $3.00 and place a 20% trailing stop. If the stock falls to $2.40, you are stopped out. But let’s say it rises to $3.50. Your new stop would be 20% of $3.50, or $0.70. So, if the shares then fall to $2.80 ($3.50-$0.70), your stop will kick in. But now, you see, that instead of losing the $0.60 that you would have with the absolute stop, you only lose $0.20 (your original investment of $3.00 minus the stop price of $2.80).
I want you to know that there are also plenty of advisors who don’t believe in stops. But I believe that wise investors should use all the tools at their disposal. And I have found that stop-losses have worked very well for my subscribers and are great tools for stemming potential losses.
There you have it—the ABC’s of buying stocks. I hope this helps you choose the right brokerage firm for you, takes some of the mystery out of the jargon that investment pros throw around, and that it also increases your level of comfort as you progress in your investing life.