July 23, 2020
When it comes to investing, free is not necessarily a good thing.
A dangerous trend over the past year or so is that many brokerages now allow customers to trade stocks without any commission. That’s causing more people to treat investing like a game because there’s no cost to buying and selling. And during the pandemic, trading stocks seems to have become increasingly popular. For some it is the replacement “sport” while most professional leagues are shut down.
I can’t believe I need to say this, but here goes: Investing is not a game.
Let’s review a few keys to building financial security.
If you are investing for a long-term financial goal, such as retirement, you are beyond nuts if you don’t have a diversified portfolio. Diversification means owning dozens, if not hundreds of stocks. That reduces the risk that any single stock can send your portfolio plummeting if something goes awry.
And it’s never been easier to buy instant diversification with an exchange traded fund (ETF). They work a lot like a mutual fund, but unlike the high initial minimums for investing in a mutual fund (it can be $1,000 to $3,000 to get started with a mutual fund), there are no investment minimums with an ETF. Plenty of brokerages have no minimum to open an account, so once you open an account you can invest small sums in an ETF and instantly own shares of hundreds of companies. That’s smart diversification.
If you are interested in individual stocks, my advice is to give yourself only a very small amount of money for this if you are just starting out or are investing for a long-term goal. There are simply way too many risks of having your future completely riding on a handful of stocks. And if you want to be smart, build a diversified portfolio of 20 or more stocks, from different parts of the economy. That’s where fractional shares can help.
And please don’t ever mistake investing for a game. Last month it seems that many Robinhood investors bought shares of Hertz, the car rental company. That has declared bankruptcy. To be clear, when a company declares bankruptcy, bond investors might get paid back some of their money (eventually), but stock investors won’t. This was beyond alarming. And it’s a sign that many investors have a lot to learn.
I also want to make sure that any budding stock traders understand that if you have a regular taxable account, every trade is a taxable event. An investment you owned for less than one year and sell at a gain will be taxed as ordinary income. An investment you owned for more than a year and sell at a profit will be taxed as a long-term capital gain. If you have losses on any sales, you can use them to offset gains, and if there aren’t enough gains, you may be able to deduct your loss (up to annual limits) on your tax return. I really doubt the brokerages and apps pushing online trading are mentioning all the tax implications, so it is up to you to be informed about all aspects of investing before you begin.