There is a right way and a wrong way to begin investing in stocks. But sometimes new investors have to learn the hard way.
A coworker recently talked to me about investing in stocks for the first time. He was proud of himself for finally taking the plunge into the market to buy a few shares. And, then I asked him what he had bought.
He said that he had bought a couple of shares of Ford Motor Company (Stock Symbol: F). He also bought a few shares of some other well-known blue chip stocks like General Electric, Dow Chemical, Walt Disney, Coca-Cola, Dr. Pepper Snapple Group, and others.
These are some great companies and a few that I own myself. But, the problem comes with how many shares he bought and the price he paid, not the companies themselves.
Investing In Stocks – A Few Shares or Many?
My friend told me that he bought five shares of Ford (NYSE:F) for example. This was one of several companies that he bought less than ten shares of when he invested a few thousand dollars. I quickly told him that spreading out and buying a just a few shares in a lot of companies may not have been the best use of his limited resources.
Should you buy a few shares in a lot of companies? Or should you buy a lot of shares in just one or two companies?
Here’s an example of why just purchasing a few shares in even a good company like Ford may not be the best idea.
If you purchased five shares of Ford at its current price of $15.66 per share, you’d have spent $78.30. But, how much did it cost you to buy those shares?
Many online discount brokers charge about $7 per trade. That’s $7 every time that you buy shares AND sell them for a total of $14. That’s quite a hurdle that you have to overcome if you want to make a profit on your stock trades.
For my coworkers five shares of Ford, he would need the share price to appreciate to $18.46 or 18% in order to just break even after you factor in the transaction costs. That’s quite a hurdle. You might have to hold onto your shares for quite a long time to get your money back without taking a loss.
Are you beginning to see how trading in small blocks of shares may not be the best idea for beginning individual investors?
But, if my friend had bought 100 shares of Ford instead of buying a lot of small positions in multiple companies, it would have cost him $1,566 total. And, he would have only needed the share price to appreciate to $0.14 or a little less than 1% in order to recoup his $14 in trading costs. That is a lot easier to do.
Consider Index Funds First
Individual stocks shouldn’t be your first thought when it comes to investing. This is especially true if you’re new to investing.
You may want to consider the benefits of investing in a mutual fund. An index fund gives you many advantages. With an index fund that mirrors one of the large stock market index like the S&P 500, Dow Jones Industrial Average, and others, you benefit from diversification that is already built in.
With index funds, you can invest just a little bit of money and own shares of the entire index and the huge number of companies that comprise it.
Another benefit of investing in mutual funds and index funds is that you get the benefit of professional investors who pick and choose which companies to invest in. Most of us have day jobs, and we don’t have enough time in our lives to track stocks like a professional does.
The transaction costs for mutual funds and especially index funds are incredibly low. You can use dollar costs averaging and purchase fractional shares with as little as $25 per month in many cases.
Is investing in stocks for everyone? Of course it’s not. But, it can be fun and adventurous too if that’s what you are looking for. But, there’s a smart way to invest in individual stocks for the first time.
Do you invest in shares of individual stocks? Or, do you just stick to mutual funds? How much of a factor do commissions and your trading costs factor into your investment decisions?
Note: I do not own any shares of Ford.