Prepared by Patrick Glenn– Staff Accountant
Investing in stocks can be a daunting task. There are thousands of stocks trading on multiple exchanges, and to top it off, there are a multitude of brokerage platforms to trade on. Money is a commodity that most people are very hesitant to risk. There is good news however: not all investments have to be extremely risky, and in today’s technological marketplace, trading has never been easier or more affordable.
There are two main ways a person can profit from stocks. The first is from the sale of a stock, commonly referred to as a capital gain or loss. First a person must buy a stock at a purchase price per share and then they must sell the stock at a later time for a different price. The difference between the proceeds from the sale and the purchase price is your gain, if positive, or loss, if negative. The second way to profit is through dividends. Dividends are profit distributions to shareholders that normally occur quarterly. Not all stocks pay dividends and they are usually not obligated to pay them, but many stocks do. Commonly referred to as dividend stocks, these stocks are known for paying dividends year after year. Dividends are normally paid quarterly and vary on the amount paid, but dividend yield is generally between 1 and 5 percent on an annual basis.
From a “small fish in a big pond” point of view, investing has three key aspects that make it difficult for the entry level investor. The first is commission fees on transactions. Many brokers charge a fee for purchasing or selling a stock. For someone trading thousands and thousands of dollars, a 7 or 8 dollar fee is nothing to worry about. But if you are investing a much smaller amount, these fees can take a large chunk of your profit. Fortunately, there are many online brokerages that allow commission-free trading. These free brokers do not always offer all the features of the other more expensive brokers but they allow you to trade commission-free which is ideal for investing smaller amounts of money.
The second problem for entry level investors is not being able to diversify investments. Without diversifying a portfolio, an investor puts themselves at a huge risk of loss. Unfortunately, many stock prices are so high that you cannot adequately diversify with a small investment. However, there are new brokerage platforms that allow investors to purchase fractional shares. This is wonderful because it allows you to diversify as if you were investing a much larger sum of money.
The final problem is one that all investors face: taxes. Capital gains have tax associated with them, which can drastically reduce your profits. The good news is that the IRS differentiates between long-term and short-term capital gains. The IRS classifies long term capital gains as property, in this case stock, bought and sold more than one year apart. Long term capital gains are either nontaxable or taxed at 15% or 20%, depending on which tax bracket you fall into, while short term capital gains are taxed at your regular tax rate. Where possible, investors should try to hold their positions at least one year to take advantage of this tax savings. This does not mean you should hold stocks that you suspect are going to continue downward or that have spiked if you do not believe the opportunity for a profit will be there after the one year holding period. Tax considerations should not override good investment decisions.
For someone just getting into stock trading, I recommend using a free broker and investing in well-established companies. This may not be the most fun or aggressive method of investing, but it tends to bring modest consistent returns over time that are far better than any savings account will pay. In today’s technologically advanced world, investing in the stock market is worthwhile for both large and small investors.