Investing Fundamentals: An Overview

Hello Authentikos Community! Welcome to our educational series. In tandem with the Authentikos Research Team, I will be breaking down financial topics and providing detailed overviews of concepts important to financial wellness. Is there a topic you would like me to cover? Reach out and let me know! 

Let’s talk about investing. Investing is a method of setting aside money in the short term in an effort to grow it for the long term. To invest effectively, one must have command over the field they play on. Just as an athlete must understand the rules of their game and the tools at their disposal, an investor must know the basic functions of the markets and be aware of the vehicles available to them. 

Whether you’ve been saving for years or you’re just getting started, you’re likely here because you want to find a way to put that money to work for you. In this article, I will break down the fundamentals of stock trading and arm you with the knowledge you need to approach your first trades.

Jared's Notes

• Investing is the commitment of money or capital with the expectation that the commitment obtains value greater than the initial expenditure. 
• Investing always has the risk of encountering losses.
• Investing in stocks is the usual way for beginners to gain experience with the markets. 

Investor Archetypes

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One of the first phases of opening an online brokerage account is answering a series of questions about your goals and level of comfort with risk. Your answers to these questions determine what kind of investor you are (at least in the eyes of the brokers you choose). Ultimately, we can boil these down to two archetypes:

The Passive Investor is not one to read finance blogs or DVR various market watches. They prefer to put their money in the hands of those who have already committed their sanity to market hawking. These investors will often opt for actively managed vehicles such as Mutual Funds. 

The Active Investor takes, as the name suggests, an active approach in managing the growth of their money. These investors will use more of the tools provided by online brokers and often trade in individual stocks and ETFs (exchange-traded funds).

Account Minimums

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Most online brokerages will require a minimum commitment, sometimes as low as $1,000, to gain access to their platform, tools, and vehicles. With the rise of retail investing we are seeing the introductory minimums fall while brokerages look to recoup in the forms of trading or account management fees. 

This is an important consideration for new investors, as while one may be put off by larger account minimums, the benefits of commission-free trading or access to exclusive vehicles could far outweigh the cost of entry. Many investors “try on” different platforms to find one that suits them.

Commissions and Fees

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You might ask, “if a brokerage waives the entry fees and account minimums, how are they getting value from my use of their platform?” Though there has been a recent downtrend in commissions on trades, I’ve still yet to encounter a charitable organization running a brokerage service. 

Brokers will, most of the time, receive a commission for every trade that you make. These fees range from $2-$10. Some platforms, like Robinhood, don’t charge any of these fees. Instead, they use the “idle money” in customer accounts and accrue interest on it. Robinhood and others will provide the option to upgrade to a premium account for a fixed fee, offering broader market access to the investor while adding a revenue stream. 

As always, it will come down to your behavior as an investor. If you trade often the fees can add up and cut into your profits. When investing small sums, be careful about floating in and out of positions as these costs can add up rather quickly and cut into the gains you think you’re making. A simple fundamental to remember is that a trade is an order to sell or purchase shares in a single company. Should you purchase or sell multiple stocks at once you will be charged for each one, not for the single action you took to perform them all. 

Say you invest your stimulus checks from this year. That’s $2,000. You do your research and find 10 stocks to invest that sum equally across. If there is a $10 fee for each trade, you’ve effectively cut your account value to $1,900 (a loss of 5%) before even having a chance to earn. 

Now imagine you’re ready to sell. You would again be charged the fee, bringing the total cost to $200, or 10% of your original account value. Unless your investments gained you that amount or more, you will have lost money just on your entrance and exit to these positions. Whenever approaching a trade, factor in the percentage loss from fees before making your move. 

Online Brokerages

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There are two types of brokers you should be aware of: Traditional and Discount.

Traditional, or full-service brokers, provide their entire range of traditional services. This includes retirement advice, healthcare options, and investment vehicles. As they typically deal with wealthier clients, it is not uncommon to find their minimum account sizes at $20,000 or higher. Many traditional brokers are capable of making good on their high costs by the value they provide the customer. However, as wages have stagnated relative to growth in previous decades, traditional brokers are not a feasible option for many potential investors. In steps the discount brokers.

Discount brokerages provide a range of tools and vehicles to command your own trades. Some even provide actively managed accounts should your desire to invest be outweighed by your desire to meticulously manage your investments. The rise of these brokers have ushered in an idea of a “democratized market”. Meaning people are beginning to take a larger role in a previously inaccessible industry. While this democratization is a wonderful development for prospective investors who fall outside of traditional brokerage’s requirements, there are  a number of fees and restrictions to be aware of. For example, amidst the Gamestop (GME) frenzy, some discount brokers limited their platform’s functionality. This allegedly disrupted a forum-led investment strategy by retail investors. 

While the liberties provided by discount brokers are attractive, be sure to make note of the liberties the platforms are allowed to take as well.

Investing In Employer Retirement Plans

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For those who do not already have a balance set aside, fear not! If your employer offers retirement plans then you might have a great opportunity already available to you. These plans often exist pre-tax, meaning that they are deducted from your salary before taxes are calculated. If you are concerned about the effect investing might have on your monthly budget, just committing a small percentage could not only empower you for your future, but also save you money on taxes now. 

It is okay to start small. As you grow more comfortable committing money toward your future, more opportunities might arise to raise your recurring commitment as your salary increases or you adjust your spending to accommodate your investments. 

Robo-advisors

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From the rubble of the 2008 Financial Crisis arose the robo-advisor. These advisors utilize algorithms to make or suggest investment decisions for you. Many robo-advisors help to lower costs and the legwork of investing for the average person. The allure of these advisors is their ability to take into account many factors that a traditional advisor might not be capable of weighing. Despite some initial resistance, many advisors now admit to utilizing robo-advisors in their investment strategies. If your aim is toward long-term growth, you would do well to utilize a robo-advisor yourself. 

Mutual Fund Fees (Loads)

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Mutual Funds are actively managed pools of funds from an array of investors which track and invest in focused manners, such as stable, high-cap stocks.

Mutual Funds behave differently than stocks or ETFs. They can only be traded once per day at market close (4PM EST). Just as their behavior and make-up differ, so too do their costs. The key fee to be aware of is the MER (management expense ratio). This ranges from 0.05% to 0.7% annually and varies from fund to fund. The higher the percentage, the more it may impact your return. 

Another term you will need to know is “loads”. These are sales charges incurred when you buy mutual funds. Front-end loads are charged at the entry of the fund, when you are buying in, and back-end loads are charged at the exit, when you are selling out. You can look for no-load funds or funds without transaction fees if you want to steer clear of these. 

Beginning investors can see mutual fund fees as an advantage when holding in tension the commissions on stocks. As long as you meet the requirements to open an account, the fees will remain fixed regardless of the size of your investment. Investing as little as $50 in a mutual fund each month can be an excellent entry point for your portfolio. 

DCA, or Dollar Cost Averaging, is an excellent strategy for beginners to familiarize themselves with. This approach reduces volatility and accentuates the commitment to long-term gains. 

Diversification and Risk Reduction

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Diversification is a difficult concept for many beginners, as they start with a relatively small investment and have trouble spreading their funds into a range of assets. If you were to invest equally into two stocks. One grew at a respectable rate, but the other went bust! You’ve now encountered a massive net loss, even though you “hit” on half of your investments. Spreading your capital helps mitigate the chance of this sort of bust, but diversifying with stocks is very difficult when you operate in such small sums. This is when ETFs and Mutual Funds become incredible vehicles for the beginning investor. 

ETFs usually track a sector, such as tech or green energy or even cannabis, and incorporate a large number of stocks. It is the easiest way to diversify your portfolio without a high-value account. Mutual funds tend to have many stocks and various other investments, enabling them to serve the diversification needs of an investor despite not being as “fun” as YOLO’ing your starting funds into a single stock. 

Beginning investors should consider ETFs and Mutual Funds before diving into individual portfolio assembly. 

Closing Time

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As easy as it might seem to start investing with a retail-trading app, beginning investors would be wise to learn the playing field and become acquainted with the array of vehicles available to them as they start their investing journey. Do your homework, make note of requirements and fees and compare them against each other. There are a number of choices you will need to make between brokerages, strategies, and commitment. As with anything worth cultivating, diligence and patience will serve you well.

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