How Does Buying Stocks Work?

Many investors buy stocks online.

Many investors buy stocks online.

Buying stocks isn't like buying a pair of shoes, but it isn't rocket science either. Each share of stock represents partial ownership in a company. As an investor, you stand to make money through capital gains when the share price increases. Many companies also give shareholders regular payouts from profits through quarterly dividends. Although investors generally buy stocks through a brokerage, you can save money by buying directly from the issuer.

Brokerage Accounts

You must open an account at a brokerage to buy most stocks. The broker then takes your order by telephone or Internet and buys the shares you want in return for a commission or fee. Some brokers offer full service, including investment advice and portfolio management, but you'll pay more for these goodies. Discount brokers offer less hand holding in return for lower fees. Electronic brokers will save you money if you prefer to trade online, but many traditional brokers also offer online trading at reduced fees.

Types of Orders

How you place your stock order can affect the price you pay. For example, you can tell your broker to buy stocks as a market order, which means you agree to pay the going market price. Or, you can place a limit order, which means you set the amount you want to pay. For example, if you place a limit order at $5 below the current market price, the broker waits for this price before buying.

Dividend Reinvestment Plans

Some companies offer a share-buying plan called a DRIP, or dividend reinvestment plan. You must use a broker to buy your first share of a company offering this system. After that, you can buy more shares by reinvesting your dividends as you get them, and you can also invest additional money in shares. For a DRIP, companies use a stock transfer agent or shareholder services provider to take your order, bypassing a broker. Although the service isn't free, the fees are usually a lot less than brokerage fees.

Direct Purchase Plan

Some companies sell their stocks through a direct purchase plan, which allows you to buy stocks at any time without having to use a broker. A transfer agent or shareholder services company handles the actual order, and the fees are lower than brokerage fees. But there's a trade-off: Because you aren't paying a broker, you won't get any investment advice.

Considerations

Although you buy stocks to make money, you can also lose your shirt. Share prices can fall as well as climb, as many investors found during the most recent recession. Most investors buy common stock, which gives you no guarantee that a stock that pays dividends today will pay them tomorrow. Even making money on stocks has its cost. You'll have to pay income taxes on your dividends every year and additional taxes on capital gains if you sell for a profit.

 

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