Earnings taxes and how to factor them into investing
You can buy almost anything online these days, from the mundane — lightbulbs, diapers — to the downright weird. (Bacon-flavored dental floss, anyone?) Like adding items to your digital cart, buying stocks online can be straightforward.
The hard part is for you to determine which stocks (and/or other securities) you're going to buy for your brokerage account. If you’re wondering how to buy stocks online, here are a few things to get you in the know.
Why buy stocks online?
Online trading doesn't cut down any of the risks of investing, but it can be a cost-effective way to invest.
Instead of paying a hefty commission to a professional broker, online brokers can charge a much lower per-trade fee to invest in the stock market, reducing your out-of-pocket costs. With a few exceptions, these fees typically run between $0 and $10 per trade.
In addition to online trading typically being a more cost-effective way to build a portfolio, it can also offer these benefits:
You control which stocks or other securities you buy (or sell) and have flexibility to buy and sell shares when it’s convenient for you.
Many online stock brokerages offer free tools that can help you understand the securities markets and decide whether to invest in them.
The Ally Invest Self-Directed Trading platform gives you the ability to build your own investment strategy and trade stocks and exchange-traded funds (ETFs) for $0 per trade on U.S. listed stocks and no account minimum.
How do you choose your investments?
When you buy shares of a stock, you're buying a piece of the company that issued it. If the stock's value climbs, so does the value of your investment. Of course, if the stock's value drops, so does the value of your investment and you could lose money when you ultimately sell the stock.
Start with understanding the basics of how different stocks work. This understanding can help you narrow down what you want to invest in at the outset.
For example, here are a few common types of stocks:
Stocks that pay a dividend, which represent a percentage of the company’s profits and are paid monthly, quarterly, or annually.
Growth stocks, which means the share price is projected to grow at an above-average rate compared to other securities.
Value stocks, on the other hand, are considered to be undervalued, based on their potential to deliver solid returns to investors.
As you compare, get familiar with the ins and outs of stock pricing. When you pull up a stock quote, you'll notice it includes several numbers:
Closing price — the last price the stock traded at during a regular trading session
Last price — represents the price at which the last trade occurred
Bid — the highest price a buyer will pay for a stock
Ask — the lowest price a seller will sell a stock
Knowing how these numbers work together can help you drill down a stock's true worth. For example, assume you want to buy a stock. Its last trade was $84.77, but the closing price was $84.12. Meanwhile, the bid is $84.76, and the ask is $84.79. (Supply and demand create this difference in price, which is known as the bid-ask spread.) How much would it cost you to purchase shares?
Since the ask refers to the price at which you can buy the stock, you'll pay $84.79 per share.
You should also review a stock's performance to see how the per-share price has changed over time. Remember, though, past history doesn't guarantee future results. In other words, even if a stock has performed well over time, its value may go down at some point.
You should also consider how much money you're comfortable losing if a stock drops in value (a.k.a. your risk tolerance). Investing in stocks is inherently risky, and some stocks have more risk than others. Having an awareness of your risk tolerance and time horizon, which means when you'd ultimately want to take your investment out of the stock market, can help you decide which stocks, if any, are a good fit for your portfolio.
Diversification can help you manage your risk.
One way to potentially manage risk is to diversify your portfolio. ETFs and mutual funds can help you do that. Here's a quick primer on these securities and the differences between them.
ETFs pool together money from numerous investors to invest in a basket of underlying securities. The securities held within an ETF may be equities, bonds, options, or other asset classes (or a mix of different types).
Both ETFs and stocks are sold on an exchange (like the New York Stock Exchange), and their price fluctuates throughout the day (instead of priced once at the market’s close). Some brokers may charge a commission to trade ETFs and stocks. But others, like Ally Invest, have hundreds of commission-free ETFs.
But what about the difference between ETFs and mutual fund? With a mutual fund, money is pooled from many shareholders to buy securities such as stocks, bonds, and short-term debt with a common investing strategy.
Unlike stocks and ETFs, mutual funds are priced once per day at market close based on their net asset value (NAV), or price per share. Consequently, they are only traded once a day. Mutual funds also can have minimum investment requirements.
When it comes to investing, ETFs and mutual funds can provide portfolio diversification because they are not based on the success of a single stock. Before investing in any mutual fund or exchange-traded fund (ETF), carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses.
Are my earnings taxed?
ETFs, stocks, and mutual funds are subject to taxes when you make a profit from selling them. When you sell one of these assets for more than you paid for it (or buy a security for less money than you received when selling it short), the result is a capital gain. How long you owned the investment before selling it determines how much you pay in capital gains taxes — either short-term or long-term.
Generally speaking, if you own your investment for less than a year, it is considered a short-term capital gain, which is taxed at the same rate as ordinary income. Securities that have appreciated and are held for longer than a year are regarded as long-term capital gains, which are taxed at a lower rate than short-term capital gains.
These holding periods are significant to keep in mind when you do the math on your profits from the sale of securities. Remember to consult with a tax professional if you have specific questions on how your investments are taxed.
How do you open an online investment account?
The first step in buying stocks online is to choose a brokerage company ("broker"). Before selecting one, you'll want to compare several things, starting with the range of investment choices. In addition to stocks, certain brokers might also offer customers the opportunity to invest in mutual funds, ETFs, bonds, options, futures, and Forex.
Next, check the fees online brokers charge. Some brokers have higher trade fees than others, and some brokerages charge one fee to buy stocks but charge a different amount to invest in mutual funds, bonds, or options. And if your stock trade requires broker assistance, you might pay an additional fee for it.
Once you choose a broker, you can open your account. The amount of money you need to get started can vary from broker to broker. For example, you can open an Ally Invest Self-Directed Trading account with any amount of money.
How do you buy stocks online?
Hop on your device and navigate to your online account's trading page. Enter the stock's ticker symbol and the number of shares you want to buy.
You're getting close to buying your first stock online, but there are a few more decisions to make.
For example, are you entering a market or limit order? A market order means you're buying a stock at the current best market price. This order is usually the fastest way to place your stock trade. And if you're just getting started with investing and you plan to buy and hold your investments for the long-term, a market order could be adequate for your needs.
If you're trading a stock whose price is fluctuating rapidly though, market orders can get expensive. A limit order can help manage risk, because it allows you to set a maximum purchase or minimum sale price for a trade. You specify the price at which you want to buy (or sell) a stock, and the trade is only executed if the stock reaches that price.
A stop order is another option. It tells the market: If ABC stock trades at or through a specific price, trigger my order. You can enter a basic stop order that triggers a market order after your stop price is reached, or you can enter a stop-limit order. In that latter case, the order is activated when your stop price is reached, and then it is entered automatically as a limit order.
How frequently should you buy stocks online?
There's no prescribed number of trades any particular investor should make. What’s important is that your trading matches up with your investment strategy and your goals.
That said, day trading consists of two off-setting transactions that occur with the same security on the same day. If you exceed four or more day trades within a rolling five business day period, your account will be labeled as a Pattern Day Trade account and it could be subject to certain limitations based on the account equity (like a requirement to maintain a minimum account equity of $25,000).
Best practice: Steer clear of day trades altogether, or do your best to keep them to a minimum, so you’re not subject to additional regulations.
How does volatility affect the process?
As recent history has shown, even record-breaking bullish markets can turn bearish in the blink-of-an-eye. Such fluctuation in stock and market prices is known as volatility. Volatility can be measured by comparing current or expected returns against the stock or market's mean (average), and typically represents a substantial positive or negative change.
Some related volatility concepts include annualized historical volatility, implied volatility, and the CBOE Volatility Index or VIX.
Annualized historical volatility measures how much volatility the stock market has experienced within the past year.
Implied volatility is a way of estimating a stock's future volatility.
The VIX, which is sometimes called the “fear index,” is what most traders look at when trying to decide on a stock or options trade. Calculated by the Chicago Board Options Exchange (CBOE), it’s a measure of the market’s expected volatility through S&P 500 index options.
The concepts discussed above may make investing sound intimidating, especially when something such as the “fear index” is involved. Still, volatility simply serves as a reminder that the value of your investments can change significantly with market conditions.
Be the investor who reviews the stock holdings in your brokerage account regularly to make sure they still fit your needs and risk tolerance. Over time, you may need to make adjustments to keep your portfolio on track with your short- and long-term investment goals.