What to Know When Buying Stocks

December 11, 2009

Where can I buy stocks?

It easy to buy stocks through an online brokerage -- such as Charles Schwab, E*Trade or Fidelity -- though you’ll need to set up an account first. You can also buy stocks through several banks like Wells Fargo and Bank of America that also offer investment accounts, plus old-fashioned stockbrokers at full-service firms such as Smith Barney or Merrill Lynch.

You might also be able to buy stocks through your employer. Some 401k’s offer what’s known as a self-directed brokerage option. This is a brokerage account within your 401k, which typically provides a broader selection of investments, including stocks. Before you purchase stocks here, find out what administrative fees or transactions costs there are. They can add up.

You can also purchase stocks through a dividend reinvestment plan, more commonly known as a DRIP. They can be well-suited for people that are new to the market and have little money to invest. DRIPs, offered by more than 1,000 companies, allow you to build a position in a stock by reinvesting your dividends and, if you want, sending in extra cash to buy even more shares. Many DRIPs charge very little or nothing at all to participate, though more have started charging fees in the past five years. If you want to sign up, you must own at least one share of the company already – you can do that online through a discount brokerage.

There are also direct-purchase plans, which are essentially DRIPs that don’t require that you own shares before joining: you can simply make the initial investment through the company (or the agent administering the plan). You really need to evaluate each plan specifically to see if it offers a better deal than buying shares through an online brokerage.

What’s a bid price and ask price, or bid-ask spread?

The bid price is what a prospective buyer is willing to pay for a security, while the ask price is what the seller is willing to accept. The difference between the two is the “spread.” Spreads tend to be wider in securities that don’t trade very frequently – the wider the spread, the higher the cost to buy that security.

How much does it cost to buy and sell stock?

It varies by provider, though it also depends on the size of your account and how frequently you trade. The more you trade, the cheaper it gets (that doesn’t mean we think active trading is a good idea; we don’t). Several discount brokerages have really lowered the bar in terms of prices. Online trades can cost you anywhere from nothing to about $20, depending on the type of plan you sign up for.

If you go through a full-service broker, it’s going to cost you a lot more per trade, though you might receive more services.

What do I need to know before actually placing a stock order?

There are several options when it comes to buying or selling stocks. For instance, you can request that you buy or sell a stock at a certain price. We’ll go through a few of your options.

Market order: this is an order to buy or sell a stock at the current market price. You may not necessarily get the exact price you saw on your screen when you pressed the button -- but hopefully you’ll get something pretty close.

Limit order: this is an order to buy or sell a stock at a specific price. A buy limit order will only be executed at the limit price or lower, while a sell limit order will only be executed at the limit price or higher. Keep in mind that limit orders may not get filled because the market price may quickly surpass your limit before it can be executed.

Stop order: an order to buy or sell once the stock reaches a specified price, or stop price. When that’s reached, the stop order becomes a market order. The problem with these is that they can be activated by a short-term blip in a stock’s price. A sell stop order will sell the security at the best price after it goes below the stop price. A buy stop order is typically used to limit a loss or protect a profit on a short sale.

Stop limit: this is a cross between a stop order and a limit order. Once a stop price is reached, the order becomes a limit order.

My company says I can buy its stock at a discount. Is it worth it?

Employers can sell company stock to employees at up to a 15% discount to the current market price, according to the PSCA. Many advisors caution that no single stock should comprise more than 10% of your portfolio. When that company is also your employer, you may decide to be even more conservative. After all, if your company hits a rough patch, you don’t want to have to worry about both your livelihood and your retirement account.

One option here: Buy the stock at a discount and then sell it immediately to lock in your gains.

What’s a stock option?

Companies often award stock options to employees as a form of compensation. Senior executives get options most often, though tech companies often award them to everyone. The employee is granted the “option” to buy company shares at a certain price for a specific period of time. They come in different flavors, but that’s the gist.

Don’t confuse employee stock options with options that trade on an exchange – though they’re similar in concept. Those option contracts generally give investors the right --- but not the obligation -- to buy or sell a fixed number of securities at a certain price within a specific time frame. Puts give you the right to sell, while calls provide you with the right to buy. Investors employ sophisticated strategies using these options to manage the risk in their portfolios – they can be used to generate income or hedge a bet, among other things. These are tricky to execute – and better left to sophisticated pros (or investors working with experienced investment advisors).