Welcome to Part 3 of a 5-part series for the brand-new stock investor – or the person still thinking about it! My goal in this series is to try to simplify how to get started in this most exciting financial journey. If you’re just jumping in at this post, you won’t get a whole lot out of this series unless you go back and start with the first post.
My hope is that you’ve taken some time to think about the last post, namely which source(s) you’re going to choose to find which stocks to invest in. Again, whether you choose to seek professional advice through an investment advisor/stock broker or not, I strongly urge you to subscribe to a stock recommendation service like The Motley Fool’s Stock Advisor or another service that someone has recommended or that customers rave about. I cannot emphasize enough the benefits of being at least a bit educated yourself so that an advisor/broker who doesn’t have your best interests in mind can’t easily take advantage of you.
So let’s get right to it: how should you go about buying your first stock?
I’m going to answer this by breaking things down into steps.
Make sure you have the money
In the first post, it was recommended that you only invest in stocks (or anything else) with money above and beyond what you need to pay for your life expenses, plus money that you don’t need for at the least next 3 to 5 years. Now, I’m going to give some suggestions as to how much you might start off with.
I recommend having $1,000 to buy two stocks with. It’s simply wiser to diversify, to have your money spread into two investments instead of just one. It’s that old saying, “Don’t put all your eggs in one basket” or in this case, all your investing money into one stock!
Could you start out with less? Certainly. You could start out buying two stocks with $500, for example. However, for me it costs $9.95 per stock trade (buying or selling), so I’d rather pay that fee on a $500 stock purchase than on a $250 purchase.
Perhaps you’ve found a way to pay less per stock trade, like $4.99 or even $0.99. First of all, I hope that the service you’ve chosen is reputable! Second, I prefer the idea of a higher fee per trade because it might dissuade you from making too many trades.
Why would you not want to make too many trades, even if they’re cheap? I might have alluded to this before, but successful stock investors are not short-term traders but rather long-term holders of any stocks that they buy. Frequently trading by trying to buy low/sell high or “time the market” means that you’re wasting money on trading fees. Also, you need to allow each stock that you own to take advantage of the power of time to grow and then multiply your investment. This absolutely will NOT happen if you’re getting in and out of stocks all the time.
To use an analogy, you need to let a ‘plant’ grow by not uprooting and transplanting it all the time. A ‘plant’ under too much stress has a hard enough time growing let alone shooting out ‘branches,’ i.e. multiplying your returns.
PLEASE TRUST ME ON THIS ONE. I used to be a trader who was getting nowhere fast (most often losing) because I wasn’t allowing time to build an investing cushion. Once I finally decided to put into practice that age-old investing idea of ‘buying and holding’ and BEING SERIOUS ABOUT IT, i.e. not wavering when things looked scary at times, ONLY THEN did I begin to see very impressive results for the first time as a stock investor after nearly two decades.
Okay, enough preaching for now about the absolutely vital need to be patient with any stock that you buy. Let’s keep going.
Make sure you have a short-list
The Stocks app on my iPhone currently lists 27 stocks and REITs (real estate investment trusts in my wife’s Canadian RRSP) that we’re currently invested in, but over 90 more that I’m keeping my eye on!
Some of the stocks in my not-so-short-list or ‘watchlist’ are ones that I owned in the past, but I glance at their prices from time to time to remind myself of how the ones I’ve replaced them with have mostly turned out to be the better choices! (More about when to sell in the next post.) But the majority are ones that I’ve done some degree of research on and would be willing to buy if ‘the price is right.’
Should you have such a (ridiculously) long watchlist just starting out? No! I’m talking about a short-list here. Mine has grown this large over the course of several years.
My recommendation would be to look at the list of Stock Advisor’s ten “Starter Stocks” that they revise annually (or the top picks of whatever other stock recommendation service that you’d rather subscribe to). Then, pick two companies that you’re the most familiar with and/or whose products or services you actually use and love. Also, DON’T WORRY ABOUT THE CURRENT PRICE – just buy into owning shares in both of them. As I mentioned in a previous post, Amazon (AMZN) was a no-brainer for me: I understand it, I use it A LOT, I love it! So do multi-millions of other people across the globe. Warren Buffett has stated time and again that he only invests in companies that he clearly understands, that are easy enough for even a five-year-old to understand and explain to someone else.
Should you actually trust a service like The Motley Fool/Stock Advisor? Aren’t they just trying to sell subscriptions?
First of all, these services recommend the companies that they do because the brains behind the service have done all the high-level research that you’re paying them to do – because you either don’t know how nor care to yourself. Second, they’re super-careful about their stock picks because they want you to succeed. Why? If you succeed then they succeed, and this will help boost their reputation among all the other dozens of subscription services out there. This simply won’t happen if they recommend crappy or mediocre companies because they didn’t do their homework, because they’re lazy and just want to sell subscriptions.
So services like Stock Advisor recommend quality companies, ones that will, over a 3- to 5-year holding period, almost always gain in value, so the buying price is really inconsequential when you’re just starting out. Again, just buy in so that you’ll be a part of any jumps in price due to a positive quarterly report, new analyst recommendations, and the like.
But what if the price dips a bit or even drops a lot soon after buying it? If you aren’t willing to give this at least 3 to 5 years to pan out, then again, don’t bother even investing in the first place. Even at the start, there’s a 50/50 chance of a price drop after you buy any stock, so you just have to learn to live with this reality of stock investing.
But to paraphrase a popular saying, ‘It’s not what happens to you, it’s how you react.’ If you can learn to take any price dip in stride no matter how scary, especially when it puts your stock below what you paid for it – most likely in the early days of owning it – then you’ll have done what few investors have ever had the guts to do. And as I’ve reminded people time and again, any loss is only theoretical – a loss on paper only – until you actually sell a stock! Why not wait until you can at least break even if you eventually decide that stock investing is too stressful for you?
Calculate how many shares of each that you want to buy
Okay, we’ve finally reached the point where you’re ready to place the order to buy with your advisor/broker, or to click the “buy” button on the order page of your self-directed online investing account. But first, you need to figure out how much you’re willing to pay per share of each stock so that you can calculate how many shares to buy.
Suppose the first stock that you’re going to buy, Stock A, is trading at around $40 per share and Stock B is trading at around $30 per share. Why I write “at around” is because, on a typical trading day, the $40 stock might trade from anywhere between $38 and $42. On occasion, it might even plunge to below $35 or surge to above $45. But you need to pick a price on the day that you want to buy that you’re willing to pay in order to calculate how many shares you want to buy without going over your budget.
I usually pick a stock price to do my calculation with by watching the price for a bit to find out the average price that it’s trading for at that point in the day. That way, when I place my buy order, I’m most likely to get that price instead of having to scramble around re-calculating how many shares I can afford to buy.
So let’s say you’re going to spend $1,000 total for two stocks as suggested before, or $500 per stock. The first $500 will buy you $500 divided by $40 equals 12.5 shares of Stock A and the other $500 will buy you $500 divided by $30 equals 16.66666 shares of Stock B. You can’t buy partial shares of a stock, so you wisely decide to round down: you’ll buy 12 shares of Stock A at $40 per share and 16 shares of Stock B at $30 per share. That means your total cost to purchase shares in both is:
$40 x 12 shares = $480 for Stock A, plus
$30 x 16 shares = $480 for Stock B, for a total of $960
(For the record, it’s better to round to the nearest five or ten shares, so 10 shares of Stock A and 15 shares of Stock B. But let’s stick with 12 and 16 shares for the purposes of this example.)
You have $40 left over ($1,000-$960) which is perfect because you also need to pay the trading fee for each purchase. Suppose like me that you pay $9.95 per trade, so that’s a total of $19.90 in fees, leaving you with $1,000 – $960 – $19.90 = $20.10.
That $20.10 left over is fine. It can stay in your investing account as cash. You will be adding to that amount once you’ve saved up another $1,000 and deposited it into your account.
Again, I suggest saving up a minimum of $100/month toward buying stocks or 10 percent of your net income, whichever is greater. Using $100 as an example, you can auto-transfer $100 every month from the bank account into which your paychecks get deposited to a bank account that is not linked to your debit card, i.e. an account that is difficult to make impulse-buys or withdrawals from. Then, move money into the investing account once you’ve saved up $1,000. Once you’ve saved up the next $1,000, repeat the above procedure, i.e. buying two more stocks.
You want to eventually have at least a dozen stocks in your portfolio. If you can afford to save up more than $100/month, I would highly recommend this: the more, the better. I might discuss in a later post what to do from there!
Have I recommended hard and fast rules? That is, MUST you save up $500 or $1,000 before buying your next stocks? And MUST you buy two stocks each time, or can you buy just one? Every successful investor will have his/her own suggestions, but the point is this: you need to come up with a plan and then stick to it.
Here’s another idea: The Motley Fool suggests that you never buy any stock that’s worth more than 5% of the total value of your portfolio. So they recommend starting out with $5,000 and buying 20 stocks with that so that each $250 worth of each stock equates to 5% of $5,000. That’s great if you can come up with that sort of money at the beginning plus have trading fees low enough that they don’t eat too much into each $250. The beauty of this – if you can pull this off – is the much better diversification than buying only two stocks to start.
However, my suggestion of $1,000 is that it’s a whole lot easier and faster to make your first investments. You just won’t be ‘spreading the risk’ nearly as much with only two stocks!
Again, take all that I’ve mentioned thus far and come up with your own plan, because to not have a plan is have confusion reign from the beginning or, as one saying goes, “To fail to plan is to plan to fail.”
One last thing: be sure to click the Follow button near the top of this page. Next, click here to go to Stock Starter Series Part 4: When to Sell a Stock. See you then.