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| Is it possible to invest in stocks for free? Yes. I explain how to do it in this article. |
How Does the Stock Market Grow Money?
One of the misconceptions people have about the stock market is that it creates wealth. The stock market doesn't do any such thing. There is only as much wealth in the stock market as money that people invest into it.Every publicly traded corporation and mutual investment fund has a cash out value (what they could be liquidated for based on their assets - liabilities, or equity) and a paper value. The paper value is what financial advisors and analysts usually discuss. Paper value is useful only as long as you don't have to sell your investments. Once you sell your paper value is history.
Sam Walton, the founder of Walmart, once famously "lost" hundreds of millions of dollars in paper value in the stock market, This was a result of the 1987 crash. When he was asked how it felt he laughed and said it was only a loss on paper.
What Sam meant was that as long as he didn't sell his shares at the current (crashed) stock market price he hadn't lost anything at all. He died a very wealthy man and his children are all billionaires because he didn't believe in paper value.
The only way the stock market grows money is for people to invest more money in the stock market. The money is paid to other people who are selling stock.
The amount of actual monetary value of an entire stock exchange changes every day because investors and companies are constantly selling shares and pulling money out of the market. So the total value may go up or down based on the net difference in what comes in and what goes out.
How Do Individual Investors Grow their Wealth through Stocks?
As long as people continue to invest in the stock market you have an opportunity to grow your wealth. There are 3 ways to do this.- Buy low and sell high - the classic investment strategy
- Buy dividend paying stocks that gradually pay for themselves
- Sell options on future trades (hopefully profitable trades)
The current stock market economy is built around the concept of "buy low and sell high". Investors don't care about how profitable the companies they invest in really are. All they care about is how much profit they'll make when they sell their shares in the future.
There are two ways to buy low and sell high.
The first way is to buy shares at market price (or a discount through an employee stock option plan or other investment plan) and then sell them later when the share price has increased.
The second way is to short sell shares when the price is crashing. Short sellers sell their shares first and then buy them later at a lower price. How can they do this? They borrow shares on margin from brokers. The short seller takes a risk that the share prices will turn around and start growing.
At some point the broker requires the short seller to cover the cost of the shares they borrowed. Or, rather, the short seller is required to buy back the shares at current market price. If the current price is less than the short seller paid she makes a profit. If the share price hasn't dropped low enough she loses money.
Dividend Reinvestment Plans Are Popular with Long-term Investors
If you have ever bought shares in a company you work for and allowed them to accrue value over the years (you didn't sell), you probably received quarterly statements showing how much dividend you were paid for those shares. The dividends may have been used to purchase fractional shares.This is the traditional way that long-term investors make money. If you hold on to your shares for 10 years or longer chances are very good their price will increase over time. Things work out even better if the company issues one or more positive stock splits.
A positive stock split is where you get 1 or more additional (sometimes fractional) shares of stock in exchange for each share you already own. Profitable companies split their stocks to reward long-term investors and keep stock prices in a desirable trading range.
A reverse stock split combines outstanding shares into fewer shares. As an investor your dollar value in the company doesn't change but you end up with fewer shares of stock. If you own 100 shares of stock in a company and it issues a reverse stock split of 4:1 you end up with 25 shares, equal in total combined value to the total combined value of the pre-reverse split 100 shares.
Companies use reverse stock splits to protect their share prices when investors sell off more shares than they buy, driving down the price.
Dividend reinvestment plans protect you from selloffs because they constantly build value in your position in the company.
Some companies pay dividends only out of profits. Other companies pay dividends from a mix of profits and loans, or they may borrow money to pay dividends. Savvy investors prefer companies that only pay dividends from profits.
A very small percentage of dividend-paying companies increase their dividends year over year. After 25 years of contiguous increases they are considered Dividend Aristocrats.
Dividend Investing Is a Better Long-term Strategy for People
Because you don't know which stock prices will go up or down, buying low and selling high requires a lot of research and thought.Dividend investing is easy to do because you only buy shares in stocks or mutual funds that have a history of paying dividends.
Many financial experts say it's better to invest in mutual funds because they spread your risk across many companies.
And most financial experts say the safest investment is in an Exchange Traded Fund or a popular Index Fund (same thing, different labels). These index funds buy and sell shares of stocks in companies listed on certain indexes. The two most popular indexes are the Standard and Poor 500 and the Dow Jones Industrial Average.
Every major brokerage offers at least one fund based on both of these and several other indexes. Their share prices grow over time because the values of these funds historically grow more than they they decline.
However you get into the stock market, if you don't have time to become a financial expert in any industry, it's better for you to invest in a stock or fund that reinvests the dividends it pays to you.
Your profit or loss for your shares equals ( cost of shares ) less ( selling price and total dividends paid to you ). Many dividend investors eventually realize a profit if they hold on to their shares long enough (typically 5 years or longer).
Should You Care about the Dividend Yield of a Stock?
The dividend yield for any stock or mutual fund is calculated by dividing its current market price by the total combined dividends for the last year.Dividend yields are theoretical numbers. You can use the dividend yield to calculate how long it takes you to earn back the cost of your shares. You should only calculate this kind of dividend yield based on your own purchase price, not the current market price.
Most stocks and mutual funds have dividend yields between 1% and 5%. It will take a long time for your investments to pay for themselves only through dividends.
Fortunately, compounding your investment through dividend-based purchases of fractional shares - combined with future stock splits - means your investment grows in value faster than just through simple dividend-to-purchase ratios.
A few stocks have much higher dividend yields. Why these yields are higher varies. You should be careful about picking a stock with a high dividend yield. It could be the company is trying to prevent its share price from slipping into penny stock valuations (less than $5 per share). Most institutional investors - whose money can make or break companies' book value - avoid penny stocks.
But you might find some good bargains in the penny stock range if the companies are profitable. Their stock prices may have collapsed for reasons that have nothing to do with their long-term viability. Their existing investors will have lost a lot of book value and may be angry. But if someone else has lost $15-40 in per share book value, and the stock is paying dividends without borrowing money, it may be a better long-term investment for you than it was for the previous generation of investors.
I recommend you only buy a stock that is not losing share price every month. If its price has been stable for at least six months it may have hit the bottom and is ready to start growing in book value (market price) again.
How Do You Invest in the Stock Market for Free?
I went on at such length about dividend investing because that is the best way to invest for free. Once you make the initial purchase you never have to put money into the stock again if you don't want to.This is a great way for ex-employees to continue building their stake in a company they have left, if they believe its stock has a future.
Another way to invest for free is to ask friends and family to buy stock for you as a gift. There are tax considerations for giving and receiving stock so be sure to consult with a financial planner or tax accountant. At the very least, read the tax booklets the government makes available for free on their Website.
One thing that is changing about how people invest in stocks is the cost of buying and selling shares. Traditionally brokers have charged trading fees. Over the past decade these fees have come down.
Now there are a few mobile investing apps like Acorns, Robinhood, and Stash that allow you to deposit money into trading accounts and buy shares without paying brokerage fees.
I have used Robinhood and I love the service but you should investigate all of them. You'll love this article from Top Ten Topia reviewing micro investing apps, as these services are called.
How do these brokers make money?
They earn interest on uninvested deposits. They also delay the trades until they can execute a lot of them together, thus saving money in their own service fees. And they may offer you premium services - such as instant trades - for a fee.
The micro investing industry is legitimate and it's only a matter of time before all the major brokers follow their lead and offer free trading plans.
