How to buy a stock
Since my last entry was on real estate, which is admittedly not everyone's foray, I've decided to alternate with a stock investing entry. Investing in stocks has a few added benefits over real estate. They are as follows:
1. Averaged over the past 100 years, including every recession from 1907 to the current bear market, the stock market has the longest on equity return of any traded security. In plain English? Investing in companies bigger than your own is a surefire way to make money in the long-run, more-so than currency trading, real estate, commodities, or anything else.
2. Your stocks are much more liquid than a real estate investment. While you can usually quite simply sell a stock and get fair market value for it at any given time during trading hours, getting your money out of real estate is a much more time consuming ordeal. You either need to contact a bank and sell them a secondary lien against the property or acquire a Home Equity Loan to tap into the value of your property. Either that your you need to arrange a buyer to buy your property. Either way is much more time consuming than simply clicking on "sell" or a call to your broker.
So that being said, there is much, much more to buying a stock than simply buying a stock. Sounds weird, right? It won't by the end of this entry.
Suppose you want to own 100 shares of company X. So what do you do. Do you just call your broker and say "I'd like to buy 100 shares of X."
The answer is a resounding HELL NO!
When you purchase a stock, it is utter HUBRIS to assume that you know when the best time to buy is. NOBODY in the world can predict a stock bottoming in price. So how do you solve this issue?
You do something called "scaling on." If you want to own 100 shares of Company X, you start by buying 25 shares of Company X. Here's why.
Suppose you buy 100 shares of Company X and the price of each share goes up 10 dollars. You just made 1,000 dollars! Good for you.
However, in the equally likely case that Company X's shares go down 10 dollars, you've just lost 1,000. In this case, you have no strategy. You just bought and hoped that the stock would go up. When it doesn't, you feel like quite the horse's ass (let me tell you I've done it before and I have felt like a horse's ass!). So let's examine the scenario if you scale on.
You own 25 shares of Company X. If the price goes up 10 dollars, you've made 250 dollars. You can sell them and pocket that money if you'd like.
Here's where the scaling on really benefits you though...
Suppose Company X's price per share goes down 10 dollars. Now, instead of just losing money, you BUY 25 more shares. If Company X was initially bought at 100, and you buy more at 90, averaged together the cost per share has now come down to 95. Now, if the stock goes back up 10 points-- that is, to the exact same price you bought the first 25 shares for-- you could sell for a profit.
Suppose the stock drops another 10 points, to 80. You buy 50 more shares. Now you've averaged your cost down to 87.5 per share. If the stock returns to the initial price you set your eye on it, you could sell it for $12.50 profit per share- and the price has never gone above what you initially would have bought it for!
Scaling in is so important that I talk about it even before the second most important rule: Diversification.
Note: I don't think you should buy 100 companies-- I think for an initial portfolio, 5 good solid companies are all you need. However, each of these companies NEEDS to be in a different sector. Why is this? Because 50% of the stock's move is affected by the SECTOR it's in and has nothing to do with the company. So if you bought Chevron and Exxon-Mobil instead of just buying one or the other, you'd be twice as prone to SECTOR RISK. You should instead spread your initial investments out among many different types of stocks.
...Oh, and that being said, never, ever invest in an airline stock. My first investment was in Continental Airlines and I lost a lot of money. Don't ask me why, perhaps it's the razor thin profit margins or the masses of competition, but airline stocks just plain suckity suck suck suck. My favorite companies are always ones that provide something that people NEED no matter what. They're not as sexy as tech stocks, but they perform the best. One of my favorite companies over the last five years is Potash. They are a fertilizer supplier. How boring is that? But they have international exposure during a mounting food crisis. You couldn't ask for much better of an investment of that.
I'm starting to realize this blog entry could go on for ages, so I will have to cut it short and continue some other time. I do want to touch on dividends-- they can be important, but Warren Buffet says that a company that does not know how to reinvest its earnings properly is the only company that issues dividends... I won't get into it too much, but it's for taxation reasons. Still, a dividend is a nice thing for a stock to have, and some of the really beaten down stocks have dividends in excess of 5 - 6% annually these days-- which is a return greatly in excess of the meager returns that Certificates of Deposit offer!
Review:
1. Stocks are the best on equity return of any investment. A well diversified and properly constructed portfolio will do well over the long run.
2. Never buy all at once, that's just hubris! Buy 1/4, 1/4, 1/2, of your position. Or if you want to be more conservative, 20%, 20%, 30%, 30%. The first one is easier to average your cost basis, and it's up to you to decide whether you want to add a second commission.
1. Averaged over the past 100 years, including every recession from 1907 to the current bear market, the stock market has the longest on equity return of any traded security. In plain English? Investing in companies bigger than your own is a surefire way to make money in the long-run, more-so than currency trading, real estate, commodities, or anything else.
2. Your stocks are much more liquid than a real estate investment. While you can usually quite simply sell a stock and get fair market value for it at any given time during trading hours, getting your money out of real estate is a much more time consuming ordeal. You either need to contact a bank and sell them a secondary lien against the property or acquire a Home Equity Loan to tap into the value of your property. Either that your you need to arrange a buyer to buy your property. Either way is much more time consuming than simply clicking on "sell" or a call to your broker.
So that being said, there is much, much more to buying a stock than simply buying a stock. Sounds weird, right? It won't by the end of this entry.
Suppose you want to own 100 shares of company X. So what do you do. Do you just call your broker and say "I'd like to buy 100 shares of X."
The answer is a resounding HELL NO!
When you purchase a stock, it is utter HUBRIS to assume that you know when the best time to buy is. NOBODY in the world can predict a stock bottoming in price. So how do you solve this issue?
You do something called "scaling on." If you want to own 100 shares of Company X, you start by buying 25 shares of Company X. Here's why.
Suppose you buy 100 shares of Company X and the price of each share goes up 10 dollars. You just made 1,000 dollars! Good for you.
However, in the equally likely case that Company X's shares go down 10 dollars, you've just lost 1,000. In this case, you have no strategy. You just bought and hoped that the stock would go up. When it doesn't, you feel like quite the horse's ass (let me tell you I've done it before and I have felt like a horse's ass!). So let's examine the scenario if you scale on.
You own 25 shares of Company X. If the price goes up 10 dollars, you've made 250 dollars. You can sell them and pocket that money if you'd like.
Here's where the scaling on really benefits you though...
Suppose Company X's price per share goes down 10 dollars. Now, instead of just losing money, you BUY 25 more shares. If Company X was initially bought at 100, and you buy more at 90, averaged together the cost per share has now come down to 95. Now, if the stock goes back up 10 points-- that is, to the exact same price you bought the first 25 shares for-- you could sell for a profit.
Suppose the stock drops another 10 points, to 80. You buy 50 more shares. Now you've averaged your cost down to 87.5 per share. If the stock returns to the initial price you set your eye on it, you could sell it for $12.50 profit per share- and the price has never gone above what you initially would have bought it for!
Scaling in is so important that I talk about it even before the second most important rule: Diversification.
Note: I don't think you should buy 100 companies-- I think for an initial portfolio, 5 good solid companies are all you need. However, each of these companies NEEDS to be in a different sector. Why is this? Because 50% of the stock's move is affected by the SECTOR it's in and has nothing to do with the company. So if you bought Chevron and Exxon-Mobil instead of just buying one or the other, you'd be twice as prone to SECTOR RISK. You should instead spread your initial investments out among many different types of stocks.
...Oh, and that being said, never, ever invest in an airline stock. My first investment was in Continental Airlines and I lost a lot of money. Don't ask me why, perhaps it's the razor thin profit margins or the masses of competition, but airline stocks just plain suckity suck suck suck. My favorite companies are always ones that provide something that people NEED no matter what. They're not as sexy as tech stocks, but they perform the best. One of my favorite companies over the last five years is Potash. They are a fertilizer supplier. How boring is that? But they have international exposure during a mounting food crisis. You couldn't ask for much better of an investment of that.
I'm starting to realize this blog entry could go on for ages, so I will have to cut it short and continue some other time. I do want to touch on dividends-- they can be important, but Warren Buffet says that a company that does not know how to reinvest its earnings properly is the only company that issues dividends... I won't get into it too much, but it's for taxation reasons. Still, a dividend is a nice thing for a stock to have, and some of the really beaten down stocks have dividends in excess of 5 - 6% annually these days-- which is a return greatly in excess of the meager returns that Certificates of Deposit offer!
Review:
1. Stocks are the best on equity return of any investment. A well diversified and properly constructed portfolio will do well over the long run.
2. Never buy all at once, that's just hubris! Buy 1/4, 1/4, 1/2, of your position. Or if you want to be more conservative, 20%, 20%, 30%, 30%. The first one is easier to average your cost basis, and it's up to you to decide whether you want to add a second commission.
