How to Buy Stock for Your Investment Portfolio
Over the past couple of centuries, business ownership, including ownership of publicly traded companies in the form of common stock, has been the most lucrative asset class for those wanting to build wealth. Despite the higher-than-average volatility, when you buy stock and earn the legal right to participate in the profits and losses of the enterprise, your money can grow in a way that simply isn't possible with bonds, certificates of deposit, or in some cases, even real estate. For new investors and would-be investors, one of the more common questions asked involves how to buy stock; the mechanics of actually getting your hands on that piece of ownership entitling you to dividends that are direct deposited or mailed to your family so you can enjoy the stream of passive income.
There are several different ways to buy stock, each with its own advantages and disadvantages, including tax and liquidity considerations. Some popular options can help you gain a general layout of the land, and be better informed to make decisions of equity acquisition.
How to Buy Stock in a Regular, Taxable Brokerage Account
If you want to buy stock with no restrictions, no tax advantages, and no contribution limits, the easiest way is to open a brokerage account. Choosing a specific brokerage house involves several considerations, such as whether you want a full-service broker or a discount broker that does nothing more than executing your stock trades at rock-bottom prices, but these days it is as easy as taking five minutes to fill out a series of questions online.
Imagine you wanted to open an account at Charles Schwab & Company, one of the biggest brokers in the United States. You would fill out the online application, providing your name, address, social security number, employment information, and more depending upon whether or not you wanted to add margin debt capability or stock option trading privileges. You would then send in the minimum account balance of $1,000 or, alternatively, sign up for $100 per month direct deposits or electronic sweeps from a Schwab checking account.
Once your brokerage account had been opened, you would see the cash deposited and parked, waiting for you to do something with it. You would log on to the website, enter the ticker symbol of the company you wanted to buy, enter the number of shares you wanted to purchase and submit the trade in a few clicks once you had verified the details. In most cases, within a second or two, you'd see the stock deposited into your account and the cash withdrawn. A few days later, you'd receive a trade confirmation document.
Whenever the company paid a dividend, you'd see it direct deposited into your brokerage account. If the company ever had a tax-free spin-off or split-off, you'd see those shares deposited into your brokerage account, as well (e.g., Chipotle Mexican Grill was split off from McDonald's while Allstate Insurance was spun-off from Sears).
How to Buy Stock in a Roth IRA, Traditional IRA, SIMPLE IRA, SEP-IRA or Other Similar Retirement Account
From a nuts-and-bolts perspective, the process of buying stock in a Roth IRA or any of its related cousins is practically identical to buying stock in a regular, taxable brokerage account. If your IRA is held at a brokerage firm, you follow the exact same procedure. The difference has to do with how the taxes are treated and the amount of new cash you can contribute each year.
For example, you can only contribute $5,500 to a Traditional IRA if you are 49 years old or younger, and $6,500 if you are 50 years of age or older. As long as you fall below the income limits in effect for the year based upon your marital status, you can write off these contributions as if you never made the money. Meanwhile, the dividends and capital gains your money earns while invested in stock within the Traditional IRA are completely tax-free with only a handful of exceptions. When you go to pull the money out of the account, you pay regular income tax on the amount withdrawn.
If you try to withdraw the cash too early, you'll be subject to a 10% penalty fee unless you meet one of the eight exemptions.
How to Buy Stock Through a Direct Stock Purchase Plan or Dividend Reinvestment Plan (aka DRIP)
What if you don't want to open a brokerage account? You're in luck. Many companies, especially large blue chip shares, sponsor programs that allow you to buy stock directly from the firm's transfer agent for free, or at a heavily subsidized price. Consider the modern day descendant of John D. Rockefeller's oil empire, Exxon Mobil. It sponsors a direct stock purchase plan through a business called Computershare. Would-be owners who open an account with either $250 or agree to have $50 per month withdrawn from a checking or savings account can buy the stock at no commission.
Even better, the plan allows fractional stock purchases so every single penny gets put to work for you, the investor, even if you don't have exactly the right amount to acquire a full share at any given time.
When you apply online, you can tell the transfer agent whether you want your dividends direct deposited into your checking or savings account or reinvested in additional shares of stock. Decide carefully. While there is no right or wrong answer — it all depends on your personal financial situation and the subsequent performance of the stock itself — there is a big difference between reinvesting and not reinvesting your dividends over long periods of time if you're fortunate enough to find yourself in possession of a truly outstanding enterprise.
How to Buy Stock Through an Employee Stock Purchase Plan
One of the biggest overlooked benefits in corporate America, a lot of huge companies allow employees to become an owner of the firm at attractive discounts, often as high as 15% off the stock market price, through programs known as Employee Stock Purchase Plans. In fact, some academic research shows the typical employee gives up between $4,000 and $5,000 in free money a year by not taking advantage of ESPPs they are entitled to join.
In most situations, you need to go down to the human resources department and ask for an enrollment form. You tell the company how much of your paycheck you want withheld to buy shares. Each pay period, part of the money you would have earned is, instead, used to buy stock at a cheaper price than you could have paid through a brokerage firm (e.g., for a company with a 15% discount, a $100 stock would be sold to you for $85, giving you an instant $15 profit).
How to Buy Stock Through a Mutual Fund
If you don't want to pick individual stocks, but want to own stocks regardless, your best bet is a mutual fund; most likely a low-cost index fund. In short, you write a check or have the initial amount taken out of your bank account so your money is pooled with other investors. The fund managers then use the cash to go out and buy stocks on your behalf, holding them in a centralized, consolidated portfolio that is, itself, divided into shares that you own. In addition to a commission, which you might have to pay, you indirectly pay your share of the fund's cost, which is expressed as the mutual fund expense ratio.
Let's imagine you wanted to buy an S&P 500 index fund. You would open an account directly with the mutual fund company or you could have your stockbroker buy shares through your brokerage account, the latter of whom may charge you a commission on the shares whereas the mutual fund company doesn't for in-house funds. The fund allocates shareholder money to stocks based upon something known as market capitalization. The top 10 stocks, as a group, receive 17.8% of your money.
Whenever you buy additional shares of your mutual fund by sending a new check or having an electronic transfer made from your bank account, as well as when you have mutual fund distributions (made up of capital gains and dividends in most cases) automatically reinvested into the fund, you are indirectly buying stocks. The shares you own of big corporations are every bit as real as if you held them directly in your brokerage account, there is just a legal intermediary between you that offers economies of scale and diversification.
How to Buy Stock Through a 401(k) Plan
Unless you have a self-directed 401(k) at a brokerage firm, you are almost assuredly going to have to choose from a slate of mutual funds chosen by your employer to get exposure to stocks, buying indirectly as if you were purchasing a mutual fund on your own. The human resource department can help you set up your account, get your share of the free matching money that may or may not be offered, and make sure contributions are allocated to the funds you think best fit your needs.
Most decent 401(k) plans will offer at least a large capitalization stock fund, a small capitalization stock fund, and an international stock fund for those who want to own international (non-U.S. companies) that pay dividends in multiple currencies. If your 401(k) plan offered the Vanguard Total International Stock Index Fund, by way of illustration, the top 10 holdings would represent 8.3% of your assets and include Nestle in Switzerland, Royal Dutch Shell in the United Kingdom, Novartis in Switzerland, Roche Holding in Switzerland, HSBC in the United Kingdom, Toyota Motor in Japan, Samsung Electronics in South Korea, BHP Billiton in Australia, BP in the United Kingdom, and Bayer in Germany.
When you opted for this fund on your 401(k) allocation instructions, you are buying stocks in all of these businesses and then some.
How to Buy Stock in an International Company
What if you are an investor in the United States who wants to buy shares of a company headquartered somewhere outside of the country? There are a few different ways for you to do this, almost all of which are going to go through your brokerage account.
- If the foreign stock has a listing on an American stock exchange such as the New York Stock Exchange, you can buy shares by entering the ticker symbol just as you would any other domestic business. British alcohol giant Diageo PLC, for example, trades under ticker symbol DEO in the United States.
- If the foreign stock has American Depository Receipts and American Depository Shares that have been created, you can buy these in the United States through the ADS ticker symbol. This is a complex topic that would require its own in-depth explanation and is probably not appropriate for most new investors given the currency risks involved and foreign withholding taxes that might be due. An example would be Nestle, which trades in the pink sheets in the United States under the symbol NSRGY. Those are really a sort of trust fund that holds the actual Nestle shares over in Zurich, Switzerland, conveniently put together by Citibank for American investors.
- You can open a special type of brokerage account that offers global trading capabilities. Many major brokers have this service. The global trading account will hold multiple currency balances as well as shares of stock purchased directly on foreign stock markets but will cost a lot more with commissions sometimes running as high as several hundred dollars and minimum purchases often being set at tens of thousands of American equivalent dollars per trade.
- You can opt to buy a domestic mutual fund that focuses on international stocks like the one previously described in the 401(k) section of this article.
A Few Closing Thoughts on How to Buy Stock
There are a handful of other ways to buy stock, including setting up a family partnership through something like a limited liability company or even finding someone who owns shares, negotiating directly, and transferring the stock between yourselves, bypassing the stock exchanges entirely (though there is almost no circumstance under which an ordinary, non-control investor would ever find it necessary to do such a thing unless he or she were transferring shares of stock to a child, grandchild, or heir at a discounted price for various tax and inheritance reasons that are far beyond the scope of this discussion).
Suffice it to say, how you buy your stock can have huge consequences for your bottom-line profits, but in most situations, you're going to be doing almost all of your purchases through a stockbroker, a mutual fund company, or an employer-sponsored retirement plan such as 401(k) or 403(b).
The big key to success is to find good, quality companies, pay a reasonable price (or if you don't know how to do that, dollar cost average), and then do what wealthy families do by eschewing portfolio turnover. This will allow you to not only avoid frictional expenses but take advantage of deferred tax assets in some cases, which can add several percentage points to your compounding rate. That means a whole lot of extra money over decades.