Setting up an Account
First off, before you can even begin trading, you need to have a brokerage account. A broker is essentially the person who matches up buyers and sellers in the marketplace. A quick google search for online brokerage accounts will lead you to a variety of options. Pick one that offers free trades and no fees.
The broker’s goal is to get you trading, so most have quick and easy ways to start accounts online. The setup process will walk you through how to transfer money from your bank via check or electronic transfer. Then once the account is funded, you will be able to buy and sell publicly traded stock. You can buy other things too, but slow down there. You’re new to this. Let’s start with the basics.
Buying Stocks and ETFs
The most basic purchases are stock in a company or index funds. Buying stock represents ownership of the company. For example, if you buy one Tesla stock, you become a part owner of the company. Yes, you only will own approximately 0.00000000127% of Tesla, but ‘go big or go home’ does not apply to investing. Purchasing that small amount of ownership is not enough to have a say in how the company is run, but if it does well, as a rule, the stock price will rise and you will have made money on that teeny bit of ownership. That is one way to make a bit of cash, basically betting on the future of a company, assuming that it will make good decisions and be worth more in the future than it is today.
One huge caveat, though, is that the stock price also depends on how people feel about the stock. For example, with the GameStop price explosion, the company itself didn’t do any hocus pocus to make their company more valuable. Instead, the people buying and selling the company created the price increase by being very excited about the stock. Investors call this being bullish. People were bullish about GameStop, which led to extreme price increases. If you ever hear about a bull market, that is basically when the majority of stocks are charging forward in price. It’s a good thing for those who are buying stock.
Most people can trade stocks just based on a little research or a good general feeling about the future of a company. However, picking out a single company to throw all your money at also has risks. If you had chosen Delta at the beginning of 2020 and invested all your money there, for every $100 you of Delta stock you purchased in February of 2020, you would have $75 in February 2021. If, on the other hand, you had invested that $100 in Tesla, you would have $402 over the same time frame. Investing is not a guarantee. Some people win, some people lose.
To avoid some of the risk, brokerage firms created electronically traded funds, or ETFs, that are based on an index. An index can be made up of anything from big or small companies, foreign companies, or even the total market. The ETF will specify what index it is based on. These indexes are a way to invest in a mix of individual stocks, in a way that dampens both the upside and the downside. They are much less risky, but chances are good that you won’t quadruple your money in one year. As an example, if you had invested $100 in a S&P 500 ETF (an index composed of the 500 largest companies in the U.S.), your investment would be worth about $117. While that doesn’t sound like much, having consistent positive returns over a long period of time (think years) works to double, triple, and quadruple investments.
Price increases are not the only way to make money. Some stocks also pay dividends. This usually applies to larger, older companies that are flush with cash. A company’s management team might decide to distribute some of that excess cash back to its owners. When this happens, your brokerage firm will be the middle person for the transaction, and deposit the dividend directly into your brokerage account.
How to Make Your First Purchase
Now that you have a basic understanding of what you’re buying and selling, it’s time to make your first purchase. Most brokerage firms have made their buy/sell platforms very easy to use. Choose the buy option on the trading page to make your first purchase. Include the symbol of the stock or ETF you’ve chosen, and how many you would like to buy.
For what type of order you’d like to place, you have a lot of options. Ignore most of them for now. The two you’re interested in to start out are either a market order or a limit order. A market order means that whatever the stock price is, you’ll buy it. Remember, most stocks are being bought and sold every second, so the price you looked up five minutes ago might not be the price that you get when you submit your order. It might not matter if you’re buying a single stock and the price jumps $0.50, but if you’re buying 1,000 of the same stock, that’s $500 more from the moment you buy.
If you’d like to guarantee that your price isn’t above a certain point, put in a limit offer instead of a market offer. With a limit offer, you dictate the highest price that you’re willing to pay. Your stock order might take a longer time to purchase, or not even go through if the price jumps, but it also is a guarantee that you don’t spend more than you’re willing to. If you put in a limit offer when you sell, this prohibits the brokerage firm from selling lower than you’re willing to sell, but once again might mean that if prices drop, no one will want to buy your stock at all.
Taxes and Regulations
You now have the knowledge to buy and sell stocks, and you’re ready to jump on the next GameStop event, or perhaps you’re just ready to slowly and steadily build wealth through an index ETF. Whichever option you choose, you should be aware of some investment consequences.
The United States tax system favors investors who hold stocks longer than a year. If you bought and sold GameStop, you will owe any taxes on the amount of gain you had at the same rate your wages are taxed. The good news is that your broker will keep track of your gains and send you a statement at year end. The bad news is that they won’t withhold any taxes, so you might be hit by a large bill when it comes time to file those taxes. Plan for it and set aside money from your sales.
By choosing to hold your stocks longer than a year, you get a better tax rate. The less money you make, the lower the rate is, meaning you might not owe a dime on any realized stock gains you have. The more income you have (in total, not just in the stock market), the more those gains are taxed, but never more than 20%. Also, gains are never taxed if you never sell. They are only taxed when you realize the gain, a word that basically means when you sell the stock. This favorable tax rate also extends to dividends on stocks you keep for longer than a year. Buy and hold is a winning tax strategy.
If you choose to buy and sell the same stock within one day on a regular basis, your broker might freeze your account. This is due to regulations around day trading. You can get around these by having more than $25,000 in your account, or by trading less frequently. Your broker might also have other limits if you begin trying to trade more risky investments like options.
The day trading route will also create many losses and many gains. This will result in a more complex tax return, and once again, an unexpectedly high tax bill. Not all losses are tax deductible, and they are limited to either the amount of your gains or $3,000. If you’re interested in doing frequent trades, do a lot of research to understand the implications of going this route.
This guide should give you the basic toolset to start building a stock portfolio. Just remember, there’s so much more to learn. Once you get comfortable with making your first purchase and investing seems like less of a mystery, you can spread the news of the best passive wealth-building around. Good luck and happy investing.