When it comes to buying stocks and learning how to invest your money, many people have questions. The market carries with it a lot of mystery and confusion to first time investors so here are some of the most asked questions along with their answers in my stock market Q & A:
Q: What exactly are stocks?
A: When a company needs money for expansion, it can decide to sell some or all of the company to investors. The way this is done is to issue shares of stock. When you buy shares of any company on the stock market, you actually own a very small part of the company. If the company does well, your shares are likely to go up in value and if the company does poorly your shares will likely go down. Investing in stocks is a great way to grow your money, especially if you have a long term time horizon with your savings.
Q: What is the New York stock exchange and the Nasdaq?
A: They are the two biggest markets where stock shares are sold. Many of the stocks you might consider buying (or selling) will probably pass through either of those two electronic exchanges in order to find a seller or buyer on the other end of your transaction. Both markets are open 9:30 AM to 4:00 PM Monday through Friday and any trades you make will be done by just pushing a couple buttons on your computer.
Q: What determines the price of each stock?
A: Supply and demand. The more popular a stock is and the more people want to buy it means the stock price will go up. When a company is not doing well and there are more sellers than buyers, the stock price will go down.
Q: How much money do I need to start buying stocks?
A: I would recommend at least $2,000 (so you have enough to buy several different stocks) but you can get started for far less. OptionsHouse, for instance, has no minimum deposit and one of the lowest per trade fees of $4.95. I recommend them for investors of all experience levels especially because 2016 Barron’s rankings of more than fifteen online brokers put OptionsHouse in 3rd place which is quite impressive.
Q: How do I pick an online discount broker?
A: To get involved investing in the market, you will need to learn how to buy stocks online. There are about 15 or so online brokers that have comparable services. and the fees they charge per trade vary from about $5 to $10. That means each buy and sell transaction will cost that amount, no matter how many shares you trade.
Some of the best known online brokers include OptionsHouse, TD Ameritrade, E*Trade, Charles Schwab, Scottrade, Merrill Edge, TradeKing, and Fidelity. Each of those brokers are reputable and have long track records so you know your money is safe. Any of them would be fine for a beginner investor.
Q: How do I buy a stock?
A: After opening an account with any online broker and putting money in your account, you will be able to buy a stock right through your computer and Internet connection. During the hours the markets are open, you will need to log into your new broker account, find the “Buy” button, input the ticker symbol of the stock, indicate how many shares you wish to purchase, and submit your order. The rest will be taken care of automatically and you will, within seconds, get a confirmation notice that your buy order was executed. You will then own those shares and you can hold onto them for as long as you like and/or sell them whenever you want as well.
Q: What are the letters I see next to a companies name?
A: Each company has a ticker symbol which is usually three or four letters that represent the company. Those symbols are what you need to know for every stock you want to buy and sell. Many financial shows on television have a moving ticker at the bottom of the screen that shows up to date prices for some of the highly traded stocks. It is those ticker symbols that move across the screen.
Q: How do I decide what stocks to buy?
A: There is no foolproof way to pick stocks that will go up and that is indeed the goal: to pick winning stocks. Most people get their stock picks from listening to “experts” on television, on the radio, in magazines, or on the Internet. Others get recommendations from their brokers, business associates, friends, or anyone else that seems knowledgable.
As there are many thousands of stocks to choose from, it not easy to identify which ones will go up at any particular time. Picking good companies that have bright futures ahead of them will go a long way to making you money. Identifying those types of companies is where the skill lies and the more you read, learn, and take an interest in the stock market and the business news, the better your chances will be of successfully picking winning stocks.
Q: What are mutual funds and should I invest in them?
A: Some people prefer putting their money in mutual funds because then they don’t have to pick which stocks to buy and sell themselves. A fund is a pool of money from many different investors all managed by an investment company and a fund manager. The fund manager makes all the decisions on what stocks to buy and when to sell them.
If you put money into a mutual fund, you will have to pay a small fee for the management of the fund. That fee will reduce your profits (if there are any) but in return you get to have your money managed by a “professional” and you don’t have to do anything else. People who are uncomfortable investing on their own often prefer mutual funds as they are more “hands off” than buying and selling stocks on your own.
Q: What are dividends and are they important?
A: Some companies choose to return a portion of their profits directly to investors and those payouts are called dividends. Most companies that pay dividends pay out an amount somewhere between 1% and 5% per year but sometimes you will find stocks that pay even more. Not all companies have a dividend because some decide they need the money for research and development, expansion, or some other reason.
With interest rates at an all time low for the last handful of years, dividend stocks have become very popular with investors and many companies that weren’t paying dividends have opted to do so. Getting a dividend is a nice bonus and it also can mean the company feels they have enough money and are doing well enough to make the distribution.
Q: What is an IPO (Initial Public Offering)
A: An IPO is the first time stock is issued for a company as it goes from being private to becoming a publicly traded entity. Once the IPO stock opens for trading, anyone can buy shares of the company. Recent high profile IPO’s were Facebook, Twitter (buy Twitter stock), and the biggest of all Alibaba (Alibaba stock).
Q: How do I know when to sell a stock?
A: Deciding when to sell a stock can be one of the most difficult decisions you have to make as an investor. One reason to sell is if something changes with the company that affects the reason you bought the stock in the first place. That could be a change in company strategy, a failed product rollout, changing market conditions, increased competition, or a host of other reasons. Ideally, you should always keep abreast of all company news of the stocks you own so that you can make an informed decision when it comes time to possibly sell.
Other reasons to sell are if a stock has gone down and you are uncomfortable losing any more money or the opposite, if the stock has gone up and you are happy with the profit. Either way though, you might end up being unhappy with your decision if the stock reverses course or continues to go up. What I ultimately recommend is to do what your gut tells you. At the end of the day you have to sleep well at night and if your stock investment is making you uncomfortable, perhaps it is time to think about selling. You can read more about this here: when should I sell a stock?
Q: What is a P/E (Price To Earnings) Ratio?
A: The price of a companies stock divided by its earnings per share gives you the P/E ratio. This number can be used to get a quick idea of whether a stock may be overpriced or underpriced.
It must be noted that average P/E ratios can vary from industry to industry so it is best to compare the ratio of the company you are interested in buying to other companies that are in the same industry. Growth stocks typically have higher ratios than value stocks and many/most stocks have a P/E under 50. When you see a companies P/E in the single digits that usually means it is cheap and anything higher than 50 probably means it is expensive but this is a generalization.