We talked last week about the importance of investing and why it can’t wait for the million and one reasons that will always stand in your way. Until you become an owner of assets and start making money off your money, you’ll always be a renter and will live paycheck to paycheck.
Once you’ve made the commitment to start investing, the only question is how to start.
In this post, we’ll cover how to open an account and buy stocks online. We’ll also look at some risks to avoid before wrapping it up with a couple of example online investing sites to buy stocks online.
Should you Buy Stocks Online or through an Advisor?
In most regulated markets, only certified professionals can buy stocks. These stockbrokers pay for a seat on the exchanges and make their money from fees or commissions when people give them orders to buy or sell. If you’ve got millions to invest, you might talk directly with a broker but most individual investors work with an advisor or an online investing platform which itself deals with the broker.
Advisors make their money through a few different options. They can charge a commission every time you buy or sell. They can also make money through commissions when you buy a certain mutual fund. These two methods have fallen out of favor because it leads to a conflict of interest. The advisor wants you to buy and sell as often as possible or to buy certain funds even if they are not necessarily right for your needs.
The advisor industry has lately been switching to a fee-only method where you pay a percentage of your total wealth each year, averaging about 1% of your assets. This helps to remove one conflict but may cause another. Unless you’ve got a nice size nest egg, the potential fee might not be enough for the advisor to give you the time of day.
Even if a fee-only advisor agrees to take you as a client, that management fee can add up. The 1% difference on a $200k account adds up to a $374,000 difference over 30 years. The advisor may also be tempted to trade in and out of stocks to try for the big win and justify their advice. Why would anyone pay for an advisor that just buys and holds stocks?
The solution: online investing websites and the ability to buy stocks online without an advisor. These websites like TD Ameritrade
and Motif Investing
also offer some advisor services but the concept is a DIY investing tool so you can save on fees.
I’ve been buying stocks online since I got out of the Marine Corps in 2001 and have several accounts on different sites. It may seem unnecessary to have more than one online investing account but different sites offer different features. Most online investing sites charge no annual fees so there’s really no cost to having more than one account.
How to Open an Online Investing Account
Opening an online investing account is nearly identical on any of the websites. You’ll first be asked the basic personal information like name, address and to choose a username/password.
Then you will fill out a list of questions on your income, wealth, investing experience and occupation. Much of this is to classify you around your experience with investments and risk.
The online investing sites have a duty to only offer investing options that are suitable for an investor’s level of experience. Someone with no knowledge of options trading and margin should not be given access to these without helping them understand the risks first.
You will answer questions about your occupation and whether you are considered an ‘insider’ at a company as well. These are set by regulators so the online investing site can monitor trading by people that might have non-public information and could break the law by trying to profit from it.
After your account is reviewed and approved, and there are very few reasons why it wouldn’t be approved, you will link it up to your bank account with the ABA and routing number. This will allow you to transfer funds more quickly and easily than a snail-mail check. The minimum with which you can open an online investing account varies but is generally $500 to $1,000 for non-retirement accounts.
Once inside an online investing account, the features and options can be overwhelming. Most online investing sites offer excellent customer service (they better if they want a piece of a trillion-dollar market) and will guide you through some of their tutorials on the phone. It never hurts to call up customer service after you open an account and ask them to show you the most used features and how to get around the site.
All online investing sites will offer general information on each stock traded in the market as well as some basic analysis. Many will also offer 3rd-party research analysis from companies like Credit Suisse and Morningstar. As an investment analyst, this is my main reason for having multiple accounts to be able to review research reports from different companies. You probably won’t need the majority of features offered on an online investing site and sometimes the most basic sites are the best.
Since we are not focusing on a particular online investing site, I decided to use Yahoo Finance as an example of the basic information you’ll see on a stock. This is a pretty common layout and there are a few points on the graphic that you should understand.
1) The name of the company, price per share of stock and the change in price will be listed at the top.
2) The bid price is how much someone is offering for the stock while the ask price is the price at which someone is offering to sell their stock. For most stocks, these prices will be really close and you won’t need to worry about it. If the stock or fund does not have much volume (see below) the bid and ask price may be farther apart. If this is the case, it will affect how you buy the stock online which we will highlight below.
3) The beta is the general riskiness of the stock compared to the overall market. A stock that generally moves up or down closely with the market will have a beta close to one. Stocks that are much more risky than the market will have a beta higher than one while less risky stocks will have a beta of less than one. Most people don’t look at the beta but it can be a good guide to understand the potential risk in an investment you’re considering.
4) The 52-week range is the highest and lowest price at which the stock has traded over the last year. While it won’t tell you if something is really expensive or cheap, I always just like to notice if the stock is trading at its high-point or near the low. I’m frugal to the core and always think twice about buying something that is around its most expensive. By the same token, there may be a good reason that a stock price has plunged to its low and you will want to know why before you buy shares.
5) Volume is the amount of shares that are trading so far that day and the average amount of shares traded each day over the last three months. If many people are not buying and selling the stock, then the bid and ask price may be farther apart. You might have to pay a little extra to buy the shares or take a price discount to sell the shares if the average daily volume is less than a few hundred thousand shares.
If the day’s volume is significantly higher than the average, there might have been some news released about the company. You will want to check this out to make sure it doesn’t affect your decision to buy or sell the stock.
6) Market capitalization is the total worth of shares issued by the company, a rough measure of the size of the company. One way to classify companies is by their size:
- Nano-cap companies (below $50 million) and micro-cap companies (up to $300 million) are extremely small and risky investments. They are generally penny stocks and may not have to provide all the financial information required of other companies. Risk of total loss is very high and these companies are generally not suitable for individual investors.
- Small-cap companies from $300 million to $2 billion in market cap are still fairly risky but can provide some upside growth to your investments if you diversify enough.
- Mid-cap companies from $2 billion to $10 billion still offer some of the growth potential of smaller companies but the stability of larger firms.
- Large-cap companies ($10 billion to $200 billion) and mega-cap companies (above $200 billion) are the giants of the economy. They might not grow as quickly but offer more stability in their size.
7) P/E or price-to-earnings ratio is the stock price divided by how much in net income per share the company has booked over the last year. It’s the most popular measure of value used by the market but may not really mean anything.
The P/E ratio is a relative measure, meaning it only tells you how cheap or expensive a stock is compared to its own history or to other stocks. It doesn’t really tell you if the investment itself is a good buy. If a stock has a P/E of 15 against another stock with a P/E of 20 – there is nothing to say that both are expensive or maybe both are cheap. Similarly, the potential for earnings growth may be much better for the second stock and justify the higher valuation.
It is also very easy for management to manipulate earnings on a financial statement. All kinds of expenses like depreciation and the cost of inventory can be made to look higher or lower, making earnings rise or fall artificially.
I include P/E here as one of the points you should know on a stock only because it is so popular and you’d think it odd if I didn’t include it. The fact is that the measure really doesn’t help you in investing and you shouldn’t let it affect your long-term investment strategy.
8) The dividend and yield are an important point for many investors. Stocks that pay dividends usually pay them out in four installments throughout the year, regularly increasing the payout if the company can afford it. The yield is the percentage of the dividend divided by the stock price, a return you will get just from the regular cash payments.
I’m a big fan of dividend-paying stocks and love getting paid for just holding an investment. In fact, dividend stocks beat those not paying out cash by an average of 7% over the three decades through 2010. Check out Step-by-Step Dividend Investing to learn how to put dividend stocks in your portfolio and money in your pocket.
How to Buy Stocks Online
The process of buying stocks online is nearly identical across different online investing sites as well. I’ve pasted an image of a trade screen below.
1) The tabs at the top allow you to buy different types of investments like stocks, options, mutual funds and bonds. Most people will only ever need to buy stocks and bonds. Mutual funds have been replaced (in my opinion) by lower cost exchange traded funds (ETFs) which are bought just like stocks.
2) Your order type will be buy or sell
3) Quantity is the number of shares you want to buy or sell. Divide the total amount you want to invest in the stock by the price. You should never hold more than 5% of your total stock portfolio in a single company.
4) Your price type will usually be ‘market’ and will buy the shares at the best available price between the bid and ask prices.
For stocks with very low volume where the bid and ask price are more than a few pennies apart, you might consider placing a ‘limit’ order. Placing a limit order means you put in a price at which you are willing to buy or sell the shares. It’s a way to control the price you pay for the stock but the commission you pay may be a little higher. For the majority of stocks, the bid and ask price will be so close that the higher commission paid on a ‘limit’ order will not be worth saving a penny or less on the price.
5) Once you preview your buy or sell order and click through the next screen, your order will go active. For most stocks on most online investing sites, your order will be processed in less than a few seconds.
Investing Risks to Avoid with Online Investing Sites
Online investing sites will offer you a ton of information on investments from research to technical charts and strategies. The process for buying and selling stocks online is so easy that you will be tempted to ‘trade’ your investments, jumping in and out over very short periods trying to make a quick profit.
Resist this temptation at all costs. The online investing sites make their money on commissions so they want you to buy and sell as often as possible. Sure, it’s veiled in the interest of you making more money but it will end up costing you more than you make.
A few of our stock market basics apply directly to buying stocks online and online investing sites. Make sure you check out all eight of our stock market rules for investing, especially the ones below.
- With all the people on TV screaming to buy, buy, buy and the online investing sites providing more information than you can use it is just too easy to trade in and out of stocks. The average investor makes 17 trades a year according to statistics on TDAmeritrade investors. Even on the most inexpensive online investing sites, that amounts to nearly $100 a year lost to commissions.
- Mutual funds charge an average of 1.4% a year when you hold the investment. ETFs are cheaper but most still charge from 0.5% to 2% a year on the amount you invest. Add these expenses to fees charged by some online investing sites and any money earned can evaporate without you even knowing it. I’ve highlighted a low-fee alternative below but make sure you watch the fees on whichever investing site you choose.
- Investing on margin seems like a great idea until you’re sitting with your head in your hands wondering where the money went. Online investing sites will allow you to borrow money against your account (margin) and buy more stocks than you could afford otherwise. If your account value is $5,000 then you might be able to buy $10,000 in stocks and pay 7% on the borrowed money. If you earn more than the interest rate then you’ve made money. If your stocks start falling though, you stand to lose much more and could easily see your entire account wiped out. Don’t invest on margin…ever.
Some Online Investing Sites to Consider
I have accounts with four online investing sites and set my wife up with an account on a fifth online investing site to take advantage of different research and features on each. Most investors will not need so many accounts but don’t overlook the advantage of having more than one account. Some sites may offer lowest cost while others may come through with a better selection of research or investing education material.
Below are two of the online investing sites on which I invest and some of the features offered.
Motif Investing
I highlighted Motif Investing in a recent review as a low-cost leader with a really interesting concept. The website allows you to group up to 30 stocks into a ‘motif’ and buy them all for one $9.95 commission. Buy that many stocks individually on another online investing site and you could pay hundreds more.
I have a Motif Investing account for its innovative and inexpensive way to buy funds. I am a big believer in diversification but can’t always find the right mix of stocks in an exchange-traded fund. Even if there is an ETF with stocks I like, I would have to pay an annual management fee to hold the fund. With Motif Investing, I can make my own funds and don’t have to worry about annual management fees. The site also offers more than 150 pre-made funds that invest in companies around a specific theme and eight funds for investing around your target retirement date.
The social network feature on Motif is also innovative. Investors share their opinion of different motifs and stocks to help each other put together the right set of investments for specific needs. The site offers a good resource of investing education and commentary by the founder, Hardeep Walia.
Get up to $150 when you start trading at Motif Investing
There is no inactivity fee on Motif so you can potentially set up your account and forget about it without having to worry about annual management or website fees. The downside to Motif Investing is that there is no dividend reinvestment offered yet so the cash will build up in your account until you withdraw it or reinvest it into the stocks.
Ok, so that was much longer than I expected it to be and I’ve got to complement your perseverance if you’re still reading to this point. Opening an online investing account and getting started investing can be extremely easy. We’ll wrap up the series with a simple investing strategy built around long-term goals and life-stage planning next week. In the meantime, let me know if you have any questions about how to get started investing or online investing sites.
