There are actually several different types of stocks, but the ones that most traders deal with on a day-to-day basis are called common stocks. Regardless of the type of stock, they are sold on exchanges. There are several of these, but the distinction doesn’t really matter to the retail investor. You will not be dealing with an exchange anyway. To buy stocks, you need to be a stockbroker. This means that you need a broker to buy stocks and other exchange-traded securities (this is a long list, and it keeps growing). In the old days, you broker was an actual person that made a lot of money filling your buy and sell orders. These days, you can still hire these “full service” brokers, but most traders do things online themselves because it is much, much cheaper. Fees are the enemy of wealth.
Let’s say you are just starting out and only have $1000 to invest. If your broker charges you $10 to make a trade, then you are really only investing $990 of your $1000. That means that you are 1% in the hole to start and that the investment must rise 1% to get you back to even. If you decide to diversify your $1000 by buying ten different stocks, then you will start out $100 in the hole with $90 invested in each stock. That means each stock must rise more than 10% just to get back to even. This example illustrates a couple of important points.
First, trades can be of any size, and the fee is usually the same. Trading in bigger lots means you pay less as a percentage to make the trade. In addition, I hope it makes the point that fees have a big impact on your bottom line. Also, take into account that the 10% you lost is not subject to the magic of compounding, which means that you can lose hundreds of thousands of potential dollars in fees over the life of your retirement account. With all this in mind, it is easy to see that you want to pay the absolute lowest fees possible. The final lesson of this example is to consider the cost of overtrading. You need to rebalance your portfolio periodically to match your investment goals and objectives, but lots of buying and selling can eat away your profits and drive you into a hole.
If you feel like you need a lot of advice about your investments or you want to turn your money over completely to a money manager, you will need a full-service brokerage. Many people use both types of accounts for different buckets of money. If you work for an employer that sponsors a 401(k) style retirement account, they will have hired a company to manage it. In that case, you may have a little or a lot of control of how your money is invested. If you have a lot of control, the odds are you have access to an online system that works like a brokerage account, but limits you to the kinds of investments that your employer and IRS rules allow. If you want to invest your own money outside of your tax-sheltered employer-sponsored retirement account, you will need to open your own brokerage account.
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