Stocks were looking dowdy next to the hot cryptocurrency sector in 2018. In fact, most stock sectors were down last year, so why invest in stocks? The stock market has its ups and downs, but over the decade the S&P 500 has clocked an average annual return of 14.5 percent (10 percent since its inception in 1957). Not too dowdy after all when you compare it with returns of 2.8 percent for 10-year treasury bonds over the same period.
With the bulls back in the lead, stock exchanges charged into the new year. In the first quarter of 2019, the S&P 500, Dow Jones Industrial Average and NASDAQ made their strongest start to the year in decades.
Why Should I Invest in Stocks?
Stocks are the most traded investment security for a number of reasons.
- The power of compound annual returns
- An attractive risk-return tradeoff
- High liquidity
- Fractional trading
- Low fee online stock trading
A Breakdown of the Risk-reward Trade-off
All good reasons to invest in stocks. But hedge funds are returning 10–15% annually, so why not invest in hedge funds instead? Stocks are an attractive investment because among all investment securities, stocks have the best risk-return trade off. An investor who takes higher risk expects to be rewarded with higher returns whereas lower risk investments have lower potential returns. So the best security to buy is the one with the best risk-return trade-off. Both stocks and hedge funds have historically delivered around 10 percent returns but the stock investor takes much lower risk for every $1 of returns.
While both investments earn 10 percent returns, the hedge fund has a beta* of 5 versus 1 for stocks.
Asset Beta 10-year Return
Hedge Funds 5.00 10–15%
Stocks 1.00 10.5%
Bonds 1.00 2.7%
Simply put, stocks have the best risk-return trade off among investment choices.
*Beta is a measure of price volatility. The market beta is one. Hedge funds are 5 times more volatile than the overall market.
How to Buy Stocks Online for Beginners:
The do-it-yourself (DIY) investor has never had a greater choice of online stock brokers. You can rely on robo advisors to create an investment portfolio for you. Or take command of a professional stock trading dashboard at discount broker fees. Which option is best for you?
Before you can choose an online stock broker, you need to determine what type of stock investor you are.
1. The Passive Investor (Best for Beginners)
More investors are putting their feet up and becoming passive investors. Passive investors invest long term in funds that track indices such as the S&P 500 large cap (SPX), NASDAQ technology (IXIC), or AMEX Gold Bugs (HUI) indices. It is easy to understand their enthusiasm. Yet another study has concluded that passive investment funds outperform active funds long term.
The passive investor can invest in passive funds in several ways.
Online brokers – offer ETFs and indices (DEGIRO, eToro) at low or no fees.
Big fund houses – with brokerage arms often sell their own funds at low or no fees, and may offer a wide selection of other fund families (Fidelity, Vangaurd).
Robo-advisors – do all the work for you. These investing bots will create a diversified portfolio of funds (cash, bonds, etc.), reinvest dividends and automatically rebalance the portfolio to maintain your allocation (M1 Finance). Find more information on the best robo advisors here.
2. The Active Investor (Experienced Investors who Want to Choose Which Stocks to Buy and Trade)
A small percentage of active investors will beat the market. Low and no fee trading has made it possible for any investor to actively trade stocks and other securities. To earn higher returns, though, you need to earn excess returns after the high trading fees racked up actively trading stocks.
Online stock broker – provides real-time pricing, charting, indicators and risk management tools to help you gain an investment edge. Stocks and ETFs can be actively traded.
Actively managed funds – are managed by investment managers. They typically cost more to cover management and trading fees.
Direct stock purchase plans (DSPP) – allow investors to buy shares directly from the company.
Best Online Stock Brokers for 2019
What to look for in an online stockbroker?
Price risk management tools
An online brokerage platform is a marketplace that electronically matches the buy and sell orders of stocks and other securities. The market price you pay is determined where the average price of all the buy orders (called the bid price) and sell orders (called the ask price) meet. Like on eBay, you may not be able to buy at the price you bid. Because constantly fluctuating prices introduce price risk, investment brokers provide many tools to balance risk and reward.Here are three ways an online stockbroker can help you manage price risk.
A Wide Variety of Investments
A diversified portfolio of securities creates a hedge against price risk. US stocks, for example, are negatively correlated to US government bonds, gold and real estate. Not all brokers will provide direct trading in these securities. CFDs, ETFs, indices and mutual funds provide a cheaper way of getting exposure to diverse markets.
Advanced Order Types
Basic market, limit and stop-loss orders are offered by most brokers and will satisfy most passive investors. Some traders could not live without trailing stops to minimize downside risk. Advanced order types used by active traders provide flexibility to combine and set more parameters.
Market order – A market order is the price at which supply and demand meet, which is 192 in the above example. If you click on ‘Market Order’ your order will fill at this or the next best price.
Limit order – A limit order executes at a specified price or better. A buy limit order for 192 will execute at 192 or lower. A sell limit order for 192 will execute at 192 or higher.
Stop loss – A stop-loss order protects the investor from large losses by automatically executing the order once the price has fallen to a specified price. A stop-loss of 10 percent limits your risk of loss to a 10 percent decline in price.
Trailing stop – Trailing stops adjust to the market price within your set risk limit, say 10 percent. When the price falls to the stop limit, the order will be executed. The trader can benefit from upside movement while limiting downside risk.
Trading bots - Automated trading advisors combine order specifications based on if/then trading rules. They will automatically execute your trading strategies for you.
Futures and Options
Futures and options are low cost ways of hedging price risk. For less than a dollar, the investor can buy a contract locking in the price of a security at a date in the future.
Options – Options give the investor the right, but not the obligation, to buy or sell a security at a fixed price on a future date.
Futures – A futures contract is an obligation to buy or sell a security at a fixed price on a future date.
Online stockbroker checklist
Unregulated brokers are not licensed in the jurisdictions in which they are doing business. If the unlicensed broker goes out of business, investors are not insured against losses.
Insurance is available in most jurisdictions against the loss of cash and securities in your investment account if your broker fails. Whether you are a resident or non-resident, a US licensed broker with SIPC insurance provides up to $500,000 in protection ($250,000 in cash). In the UK, the FSCS provides insurance up to £85,000.
Negative balance protection
Some brokers will compensate you if your account balance becomes negative as a result of your trading activity. Margin calls are designed to limit losses by requiring an account be replenished by the investor with cash or securities if it falls below the margin threshold.
Fixed income securities
Bonds add diversification and tax benefits to an investment portfolio. Bond prices move in the inverse direction of stock prices, and thus smooth out price volatility in an investment portfolio. The interest earned on government bonds is tax deductible.
Tax-advantaged retirements plans like IRAs and 401ks do not tax earnings on investment gains. A designated retirement account is required to receive these tax benefits.[/su_note]You do not need a crystal ball to decide whether you will be better off financially in 20 or 30 years with A, B or C broker. Establish your investment objectives, and then align your trading style, risk profile, and expense ratios with the best online stock broker for your investment objectives.
What Stocks Should I Buy?
What makes a good stock picker? Good old-fashioned stock analysis. Buying stocks on a hunch or gut instinct is likely to turn into a money-losing investment venture. The best way to improve your stock picking skills is to perform fundamental stock analysis. Place these ratios in your stock analysis toolbox and use them to evaluate the suitability of an investment for your portfolio.
Earnings-per-share (EPS) – tells you how much the company is earning for each share you own. An increasing EPS is an indication the company’s profitability is improving.
Net earnings/Number of shares issued
Price-to-earnings ratio (P/E) – is a handy metric for comparing whether the price of a stock is cheap or expensive relative to its peers.
Share price/Earnings per share
Price/earnings to growth (PEG) - takes into consideration the future earnings growth potential of the company. Forecasted estimates are used for future earnings. Compare this figure to analyst estimates.
P/E ratio / Earnings growth for period X
EBITDA – Earnings before interest, taxes, depreciation and amortization reveals how profitable a company is before accounting deductions.
Book value (BV) – is the value of a company after all assets are sold and liabilities paid back. Value investors use it to determine the intrinsic value of a company.
Total assets/Total liabilities
Market value – is based on the value the market places on a stock, which is determined by supply and demand.
Current market price X Outstanding shares
A company can be enjoying increasing profitability but not be operating effectively. It may have healthy earnings growth and a solid book value, but no cash to pay its suppliers tomorrow. Here are some ratios to analyze the cash position of a company.
Price-to-cash flow (P/CF) – is an indication of how much operating cash a company is generating. It is an important metric for pre-profitability companies without earnings figures. Large cash expenditures such as share buybacks or acquisitions can affect the cash liquidity of a company.Current share price / Cash + Cash equivalents
Current ratio – one of two key liquidity ratios, it measures the company’s ability to pay short-term debt with short-term assets such as cash and receivables.
Quick ratio – called the acid test, this ratio includes assets that can be converted to cash within 90 days.
Current Assets (Cash + Cash equivalents + Receivables...) / Current liabilities
How Are Stocks Priced?
The initial price of a stock is set in the process of issuing a public stock called an initial public offering (IPO). Investment banks form a syndicate to underwrite the IPO.
They determine the IPO price by analyzing the:- Company’s private financial information- Level of investor demand
- Traded price in the private market
The opening up of pre-IPO share trading to retail traders is allowing more accurate IPO pricing to be set. Uber is an example of a company whose pre-IPO shares were available to retail traders through online brokers. Before the IPO, the stock was valued at $76 billion, which became the IPO price. In May, the IPO was priced at $45 a share, or $75.5 billion – the fourth largest IPO in US history.
Public stock pricing
The day of the IPO, the price declined 8 percent. Once a stock is public, the price is determined by investor supply and demand. Volume is one indicator of market demand. Ten days after the IPO, the stock was trading between $40 and $42, and the company was valued just under $70 billion, indicating that seller trade volume was slightly heavier than buyer trade volume.
How Much Do I Need to Invest in Stocks?
Fractional shares have significantly lowered the minimum investment amount. A fractional share is one share divided into smaller components, or fractions. These fractions are sold as separate securities. ETFs have also lowered minimum investments. Because they pool investor funds and do not have high management fees, the issuer can set any amount minimum to invest in a fund. You can trade on Robinhood with $5 and M1 Finance with $10.
How Much Money Can I Make From Stocks?
Although past performance is never a guarantee of future performance, the historical performance of a security can be, but is not always, a reliable predictor of future performance. A stock with low volatility (a large cap value stock) is more likely to replicate past performance than a stock with high price volatility (a small cap growth stock). The S&P 500 index provides a good benchmark for a diversified stock portfolio. As mentioned, since 1957, the S&P 500 has earned an annual average return of 10 percent.
More predictable is the dividend payments a stock will pay. Dividends are the regular distribution of the profits of a company to investors. Dividends may be paid out monthly, quarterly or biannually. The investor may accept cash dividend payments or reinvest dividends and benefit from the power of compound annual returns. Companies with steadily increasing and reliable dividend payments have historically outperformed the market.
How Much Will I Get Taxed?
If you hold a stock for more than a year, you will be liable to pay capital gains tax. Capital gains is the profit you make from the sale of investments, such as stocks and real estate. The amount you will pay is determined by your tax bracket.
Short-term Capital Gains
For stocks held for less than a year, you will be taxed at your ordinary tax rate on any capital gains.
Long-term Capital Gains
Taxes range from 0 percent if your income is under $39,375 to 20 percent if your income is more than $434,551.
Any capital losses can be used to offset capital gains. If your capital loss is $2,000 and your capital gain $1,000, you only need to pay tax on the $1,000.
Capital gains on stocks held in an IRA or other tax-advantaged account is not taxed.
Online broker minimum deposits vary. No fee broker models have significantly lowered the minimum. Some allow you to start trading with $5–10. Premium brokers may require that you have not only a high minimum account balance but also meet an asset test (e.g., minimum assets of $25,000].
- 1 Why Should I Invest in Stocks?
- 2 A Breakdown of the Risk-reward Trade-off
- 3 How to Buy Stocks Online for Beginners:
- 4 1. The Passive Investor (Best for Beginners)
- 5 2. The Active Investor (Experienced Investors who Want to Choose Which Stocks to Buy and Trade)
- 6 Best Online Stock Brokers for 2019
- 7 What to look for in an online stockbroker?
- 8 Online stockbroker checklist
- 9 What Stocks Should I Buy?
- 10 How Are Stocks Priced?
- 11 How Much Do I Need to Invest in Stocks?
- 12 How Much Money Can I Make From Stocks?
- 13 How Much Will I Get Taxed?
- 14 Stock Investment Risks
- 15 FAQs