This article originally appeared on The Financially Independent Millennial and was republished with permission.
The first few months of 2021 have uncovered a group of new investors interested in starting investing online by buying and selling stocks.
On the surface, buying and selling stocks may seem complicated. While media analysts and top financial experts toss about technical jargon, understanding how stocks are bought and sold is relatively straightforward. However, a brief explanation of the markets and exchanges will help you start to better understand investing online.
Here’s a rundown of everything you’ll need to start trading stocks online in 2021.
Understanding the Basics of the U.S. Stock Market
So much has been written about the financial system, in particular, the nation’s stock markets. For this article, we’ll cover the basics: those who don’t grasp the market can learn more as they invest and expand their knowledge. Educating myself about the stock market as a college student gave me the confidence to start my transcription company years later.
The first stock market got formed in Antwerp, Belgium, in 1531. Moneylenders and brokers traded bonds or debt certificates between government entities, businesses, and individuals.
Owners of large ships and shipping companies issued some of the first stock certificates to individual investors to finance long-distance trading to Asia and newly discovered lands. Selling stocks for single voyages allowed companies to spread risk among many. Later, these same companies issued stocks for multiple trips, and some even paid dividends from their profits.
Related read: How to Invest in Stocks
Modern stock markets
London was home to the first “modern era” stock exchange in 1773. The first stock exchange in the U.S began in 1790 in Philadelphia. Shortly after that, the New York Stock Exchange (NYSE) got formed when 24 men signed the Buttonwood Agreement at 68 Wall Street. Five securities, including three government bonds and stocks of two banks, began trading. Today, the NYSE is the world’s best-known stock exchange, although most large countries have their stock exchanges.
In 1971, the National Association of Securities Dealers formed the Nasdaq Exchange to allow investors to trade securities through a computerized system, making it the world’s first electronic trading exchange. Today it is a model for modern-day exchanges.
Unlike the NYSE, the Nasdaq doesn’t have a physical presence. All trades get completed electronically. It’s important to understand that stock exchanges do not own stock. Exchanges merely connect buyers and sellers.
The most considerable difference between the NYSE and Nasdaq is how stocks get traded. Stocks traded on the NYSE use an auction method. The NYSE opens each weekday morning at 9:30 a.m. (Eastern time). Orders to buy and sell begin as early as 6:30 a.m. and get paired with the highest bidding price and the lowest asking price. The NYSE’s closing bell rings at 4:00 p.m. each weekday afternoon.
In contrast, the Nasdaq is considered a dealer market. Participants don’t buy and sell among each other. Instead, transactions use a dealer. That’s why the Nasdaq is known as a market maker.
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Why Are Stock Exchanges Necessary?
Stock exchanges provide essential services to individual and institutional investors who want to invest in one or multiple companies. In short, stock exchanges and the market help companies, individuals, and even governments.
One of the most important stock exchanges’ functions is that they allow companies to raise capital for growth and expansion needs. Otherwise, companies would have to rely on loans from banks.
Companies that need additional operating capital can form an Initial Public Offering (IPO) and sell shares to investors. The company can use the funds without having to incur interest costs associated with traditional loans. However, the company must demonstrate positive growth and profitability to maintain and increase its share price.
In short, stock exchanges help:
- Companies raise capital without incurring interest costs
- Help create personal wealth
- Increase investment in the economy
- Serve as a global economic indicator
What Is a Stock?
A stock is a certificate that shows equity ownership in a company. Purchasing a company’s stock gives you ownership in that company. Each share is valued at a specific price when publicly offered. If the company meets or exceeds investor expectations, the price per share will usually increase.
However, keep in mind that many factors impact a company’s share price. Some of those factors may be beyond the company’s control.
The percentage of ownership depends on how many shares get allocated. Investors can buy and own shares of stock in private companies as well as public companies. For this article, we’ll focus on publicly traded stocks.
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The Difference between Stocks (Equity) and Bonds (Debt)
Although this article focuses on purchasing stocks, it’s essential to understand the difference between stocks and bonds. Stocks (equity) give you partial ownership in a company. Investing in bonds (debt) is a loan from the investor to a company or government in exchange for interest payments over time.
Let’s say you purchase Twitter stock. Around mid-day on March 8, their price per share is $66.28. After you buy one or more shares, you may hold them as long or short as you like. While many trading platforms allow investors to purchase stock at no cost, many brokerage houses (think Merrill Lynch, UBS, etc.) charge a commission for executing the trade.
What about bonds?
Bonds are popular with conservative investors because they generally pay interest regularly for a fixed period. For example, Treasury (government) bonds and notes pay interest every six months until they mature. Corporate bonds typically pay interest on a semi-annual, quarterly, or monthly basis until maturity.
Government bonds are popular because they are usually backed by tax dollars or revenue generated from utilities. Let’s say you purchased a 10-year bond for $2,500 that pays 2 percent interest. If you hold the bond to maturity, you will make $500 in interest (usually distributed in equal payments throughout the year). You will also get back your initial $2,500. Also, it’s why bonds are called “fixed-income” investments. Further, investors can purchase bond maturity dates ranging from a few days to 30 years.
Investors often incorporate bonds in their portfolios to offset more aggressive equity investments. The more conservative an investor is with their portfolio, the more they will invest in bonds or keep in cash. Because the Federal Reserve is keeping interest rates at historically low levels, the interest paid on most bonds has decreased.
Investment-grade bonds such as those issued by the U.S. government usually have low to medium risk, ranging from AAA to BBB ratings.
Junk bonds are corporate bonds with a credit rating BB or lower by Standard & Poor, or Ba or lower by Moody’s. The lower the rating, the higher the interest payment, and the higher the risk. Institutional investors are the primary buyers of junk bonds.
Understanding Mutual Funds and Exchange-Traded Funds
Both mutual funds and exchange-traded funds involve combining several individual stocks for a common objective. Mutual funds were first introduced in the 1920s, while exchange-traded funds made their debut in 1993.
As the name implies, mutual funds are when individual stocks are pooled together in a fund overseen by professional money managers. Average investors are attracted to mutual funds because they make investing in multiple stocks easy.
Like stocks, mutual funds offer a range of investing strategies. Highly aggressive funds are designed to produce higher returns yet can also suffer large losses. Other funds are designed to produce growth, growth, and income, or income. Other types of funds are international, tech, oil & gas, etc.
For example, if you buy ten shares in a company for $10 per share, you will have invested $100. If you invest $100 in a mutual fund, you would own a portion of each share in the portfolio.
A mutual fund’s value is based on the net asset value (NAV), calculated at the end of each trading day.
Investment firms such as Janus make money managing mutual funds by charging fees and operating expenses. Such fees can be front-end loaded or back-end loaded, so make sure you understand any fund’s fee structure before investing.
Exchange-traded index funds track the indexes of major markets. ETFs comprise individual stocks in a particular index and, unlike mutual funds, are often passively managed. One major advantage ETFs offer is investors’ exposure to a specific market sector by diversifying different stocks. ETFs usually have no front or back-end loaded fees but can come with commission fees. Today many platforms have no commission charge for any stock, mutual fund, or ETF.
Keep in mind there are differences in how mutual funds and ETFs are taxed. The most significant difference involves capital distributions paid by mutual funds. Since ETFs don’t payout capital distributions, they sometimes have a tax advantage over mutual funds. As with any investment, it’s wise to consult a tax professional before investing.
Related read: How to Invest in the S&P 500
Taxes: Short-term versus long-term capital gains
Practically everything in life is taxed. Your investment portfolio is no exception. The U.S. tax code can get complicated very quickly. As always, it’s best to consult your tax professional before making any investment decision. We’ll stick with the basics in our discussion here.
Every investor wants to make a profit. If and when a profit determines how you will be taxed. Let’s say you purchase General Electric for $10 per share and sell it for $20 per share.
If you held the stock for less than 12 months, it’s considered a short-term gain and gets taxed as ordinary income. The exact amount depends on your tax bracket.
If you held a stock for over one year, any profit is considered a long-term gain and is taxed anywhere from zero percent, 15 percent, or 20 percent, depending on your tax bracket and filing status.
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In 2020, the tax rate for long-term gains is:
- 0% if your adjusted income is $0 to $40,000
- 15% if your adjusted income is $40,001 to $441,450
- 20% if your adjusted income is $441,451 or more
Remember, capital gains are only recognized when you sell all or portions of your investments. As long as you hold any security, there is no tax.
On the flip-side, if you sell a security for a loss, you may use the amount to offset your income. A qualified tax professional can help provide guidance and advice for realized gains and losses.
Related read: How to Invest in Dividend Stocks for Income
How do I purchase my first stock, mutual fund, or ETF?
Investing in the stock market has never been easier. To buy or sell registered securities, you need to open a brokerage account. Your parents or grandparents probably purchased securities through a “stockbroker” who worked for a large Wall Street brokerage firm or local bank. Today, many first-time investors are comfortable opening an account online with a registered brokerage firm.
Whether you open an account in-person or online, you’ll need to provide the necessary information and fund your account. As we highlighted earlier, some brokerage firms charge a commission for each trade, and some don’t. Make sure you understand any associated fees before executing a trade.
Next, you’ll want to research any stocks or investments. The best place to begin is consulting leading print and online financial publications or researching the company or industry. You may remember your parents or grandparents reading the print copy of The Wall Street Journal. This publication has stood the test of time and is the “go-to” source for business news. The journal’s online edition is even more comprehensive than its print edition with video stories and podcast excerpts.
There’s always a ton of data available, so try not to get bogged down in information you don’t understand.
Arguably one of the most famous and successful U.S. investors, Warren Buffett steered clear of companies and industries he didn’t understand. Among Buffett’s other notable quotes, he said, “Buy into a company because you want to own it, not because you want the stock to go up.”
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Traditional Brokerage Firms
The early to mid-1980s saw the pinnacle rise of traditional, full-service brokerage firms such as Merrill Lynch, UBS, and Goldman Sachs. The 1987 film, Wall Street, starring Michael Douglas and Charlie Sheen, is the perfect example of how young and hungry “stockbrokers” cold-called for hours trying to pitch individual stocks to individual investors.
If you watch the movie on an online streaming service (or find an old VHS version in your family attic), notice all the large computer monitors and wired headsets brokers used in the open-area “bullpens.” Indeed, it’s where low-level brokers tried to sell enough to earn their own office. Stockbrokers worked on straight commission and got paid for each transaction.
It was around this time that technology began to transform the brokerage industry. Sure, there are a handful of national brokerage houses and lots of regional firms still around. One of the more significant changes occurred in 1975 when Congress deregulated the stock brokerage industry. Before this new law, the NYSE controlled commission rates. Discount brokers such as Charles Schwab offered lower commissions but didn’t offer research services or give advice. They merely took orders.
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Plenty of investors still maintain accounts at full-service brokerage firms. Today, stockbrokers are called “financial advisors” and promote advisory services instead of individual securities.
Few individual investors and even fewer financial advisors are comfortable researching and buying individual stocks. Today, most advisors pitch managed accounts consisting of mutual funds, ETFs, and some individual stocks, all overseen by professional money managers employed by their firms or large mutual funds such as Janus and Vanguard.
Since most financial advisors still get paid for “assets under management” or through commissions on individual transactions, one might argue that such payment structures benefit the advisory over the investor. That’s why some firms operate as “registered investment advisors” and arrange their fee structure around their client’s gains and losses versus transaction activity.
Online Brokerage Services Take Over
Not only did Charles Schwab and other discount brokers offer commission discounts of up to 70% of traditional brokerage houses, but they also offered investors the chance to place orders 24 hours a day.
When the Dow Jones Industrial Average lost 22.6% in a single Monday in 1987, this soured many small, individual investors. The 1990s saw an increase in brokerage technology as well as advances in cellular phones and computers. In 1998 the SEC approved electronic trading systems, paving the way for newer technologies.
Related read: How to Sell Covered Calls for Weekly or Monthly Income
Fast forward to today, and online brokerage firms such as Robinhood and E*Trade have practically taken over the market. Plus, younger investors are now interested in buying and selling individual stocks again. Most online trading platforms, including those of the large, more traditional brokerage houses, offer no-commission trading.
Since Robinhood doesn’t charge upfront commissions, their income is derived from selling their trades to other market makers and generating fees from their premium service.
One aspect of online trading hit Robinhood hard in early 2021. The stock market frenzy created by Reddit chat rooms sent shorted stocks such as GameStop and AMC theaters sky-rocketing. The demand for these and a few other stocks caused Robinhood’s systems to crumble.
Another point to remember is that brokerage firms, like banks, have deposit requirements. They are required to have a certain amount of cash available to meet investor’s needs. It’s referred to as net capital obligations. Because of heavy trading volumes, Robinhood paused trading on some stocks. The blowback was stiff, and Robinhood now faces tons of lawsuits from individual investors.
Nonetheless, commission-free online trading seems here to stay and will likely continue to expand.
Related read: Should you pay off debt, or save for retirement?
Placing Your Order
Once you decide how many shares of a particular company you want to purchase, you can place the order if you are comfortable with the current share price.
It’s important to remember that for every buyer, there must be a seller. If you implement a market order, that means you’re willing to buy the stock at the best available price. If the share price was $10 when you placed the order, it could be slightly higher when it got executed.
Limit orders allow the investor a bit more control over the executed price. If you feel the same $10 share is a better deal at $9 per share, then you can instruct your broker to purchase the stock at $9 if and when it hits that price. You can also designate your limit orders as “all or none,” “good for day,” or “good till canceled.”
There’s lots of other great info you’ll want to learn as your investment interest and portfolio grow. In the meantime, do your homework and invest responsibly.
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