How to buy bitcoin using a credit card – and what to know about drawbacks of using this payment method

Hand holding credit card with bitcoins around 2x1
Buying bitcoin with a credit card is possible – but it’s not recommended.

  • It’s possible to buy bitcoin with a credit card, but it depends on the crypto exchange you’re using as well as your credit card issuer.
  • Using a credit card to buy bitcoin may trigger several fees from both the credit card issuer and the crypto exchange.
  • Because bitcoin is such a volatile asset, you could end up owing more on your credit card than what it’s worth if the price drops.
  • Visit Insider’s Investing Reference library for more stories.

Bitcoin, which made its debut in 2009, is a cryptocurrency – a digital form of money that exists without a central government or bank. Over the last few years, Bitcoin has gone from an obscure method of payment to a mainstream investment option.

With its rise in popularity and the lure of massive gains, investors who may not have the largest budgets are looking for a way to get in. For some, using a credit card to purchase Bitcoin seems like a savvy way to own the cryptocurrency and use the future gains to pay off the debt and fees. But can you actually buy bitcoin with a credit card? If so, what are the risks?

Can you buy bitcoin with a credit card?

Yes, it’s possible to buy bitcoin with a credit card. But it depends on what exchange you’re using. Some crypto exchanges do allow you to buy bitcoin with a credit card – but they do come with fees.

Your ability to purchase crypto with a credit card will also depend on the credit card issuer.

“[American Express] specifically prohibits purchasing currency with their card but, for now, allows purchases of cryptocurrency,” says Courtney Richardson, Esq., founder of The Ivy Investor. If your chosen exchange and credit card issuer allow you to make the purchase, the process for setting up these transactions is very similar to the process to link and verify your bank account via ACH (automated clearing house).

Is it a good idea to buy bitcoin with a credit card?

Using a credit card to buy Bitcoin or any other cryptocurrency is not recommended. “I prefer individuals to purchase bitcoin with cash,” says Dr. Hans Boateng, founder of the Investing Tutor. Using a credit card to buy Bitcoin is a highly speculative and expensive proposition in which the drawbacks tend to outnumber benefits.

Additionally, Bitcoin purchases are usually assessed differently than regular purchases by credit card issuers. “In many cases, purchasing cryptocurrency is considered risky behavior and the credit issuer may close the card or have the credit limit lowered,” adds Richardson.

Here are the main drawbacks of buying bitcoin with a credit card:

Broker fees

Cryptocurrency exchanges make money through transactional fees but for the use of a credit card you may be charged even more. So you may be facing broker fees should you to choose to buy bitcoin with a credit card.

For example, Crypto.com allows credit card purchases and charges 2.99% for credit and debit card fees, but this is waived for the first 30 days.

Credit card fees

Generally, credit cards treat cryptocurrency purchases like a cash advance which, depending on the card you have, could be between 25% to 27% APR and would begin accrual immediately.

This is in addition to the fee for using the cash advance from the credit card issuer. In some cases it can be $10 or 3% of the cash advance, whichever is greater.

Foreign transaction fees

If an exchange is based outside of the US, your credit card may also add a foreign transaction fee for each purchase. This fee could range between 1%-3% per purchase.

Credit utilization ratio increase

There are various factors that make up your credit score. One of these factors is credit utilization ratio, which makes up 30% of your credit score. Buying Bitcoin can use up your available credit, potentially lowering your credit score. Even if the value of Bitcoin falls, your credit utilization stays the same.

Other considerations

Fees are not the only risk of buying Bitcoin with a credit card – volatility is a big factor, which Bitcoin is known for. “The most significant risk is understanding that Bitcoin is a new technology with a high level of speculation,” Dr. Hans says.

Bitcoin has had large price swings over time, which can negate the perceived advantages of using a credit card to buy crypto – and it may also put the buyer “underwater” if they end up paying more in credit card debt than the asset is worth. This becomes especially dangerous when factoring in interest on the credit card if the balance cannot be paid in full and the price of Bitcoin is falling.

While using a credit card to buy bitcoin may not be the best idea, there are a few credit cards that can help you earn rewards in Bitcoin for typical day-to-day purchases. Keep in mind that even with a bitcoin rewards card, its benefits may erode if you’re paying late fees and interest charges on the balance.

Here are a few credit cards that offer bitcoin-related rewards:

  • BlockFi Bitcoin credit card: With this credit card, all purchases earn a percentage back in Bitcoin. If you meet a certain spending threshold, you can earn a higher rate.
  • SoFi credit card: In April 2021, SoFi was the first company to redeem rewards points directly into cryptocurrency via their SoFi Invest app.
  • Brex credit card: This is a credit card for business owners and rewards cardholders up to 8x in Bitcoin or Ethereum.
  • Venmo credit card: In a recent company announcement, Venmo will enable a new feature that allows Venmo Credit Cardholders to use monthly cash back in their Venmo account to auto-purchase the cryptocurrency of their choice, with no transaction fees.
  • Crypto.com rewards Visa: Crypto.com offers a range of credit cards ranging from 1% to 8% in rewards depending on the card.

The financial takeaway

While it is possible to buy Bitcoin with a credit card, it isn’t the most sound financial decision given the risk of the asset and the fees. These fees not only reduce your potential gains, but they can also impact your credit score if your purchase is large. “Use cash to purchase, dollar cost average, and look into other ways to get rewarded for crypto,” says Richardson.

How a Bitcoin wallet gives you more security and control over your digital assetsAltcoins are the alternative digital currencies to bitcoin – here’s what they are and how they workWhat to know about non-fungible tokens (NFTs) – unique digital assets built on blockchain technologyWhat is Ethereum? What to know before investing

Read the original article on Business Insider

What to know about non-fungible tokens (NFTs) – unique digital assets built on blockchain technology

NFT Logo on glowing technology background
NFTs have become increasingly popular and have sold for millions. They can come in the form of everything from memes to pet rocks.

  • A non-fungible token (NFT) is a unique digital asset that represents ownership of real-world items like art, video clips, music, and more.
  • NFTs use the same blockchain technology that powers cryptocurrencies, but they’re not a currency.
  • While NFTs have sold for millions, they’re highly speculative assets that are not appropriate for every investor.
  • Visit Insider’s Investing Reference library for more stories.

A non-fungible token (NFT) is a unique identifier that can cryptographically assign and prove ownership of digital goods.

As NFTs for digital artwork have sold for millions – sometimes tens of millions – of dollars, to say they’re popular could be an undersell. In the first half of 2021, NFT sales hit $2.5 billion.

However, once you understand how NFTs work, you’ll see there are additional use cases for this technology.

What is an NFT?

NFT stands for “non-fungible token.” At a basic level, an NFT is a digital asset that links ownership to unique physical or digital items, such as works of art, real estate, music, or videos.

NFTs can be considered modern-day collectibles. They’re bought and sold online, and represent a digital proof of ownership of any given item. NFTs are securely recorded on a blockchain – the same technology behind cryptocurrencies – which ensures the asset is one-of-a-kind. The technology can also make it difficult to alter or counterfeit NFTs.

To really get a handle on NFTs, it’s helpful to get familiar with the economic concept of fungibility.

  • Fungible items can be exchanged with one another with ease because their value isn’t tied to their uniqueness. For example, you can exchange a $1 bill for another $1 bill, and you’ll still have $1 even though your new bill has a different serial number.
  • Non-fungible items aren’t interchangeable. With NFTs, each token has unique properties and isn’t worth the same amount as other similar tokens.

So why are people shelling out so much money for NFTs? “By creating an NFT, creators are able to verify scarcity and authenticity to just about anything digital,” says Solo Ceesay, co-founder and COO of Calaxy. “To compare it to traditional art collecting, there are endless copies of the Mona Lisa in circulation, but there is only one original. NFT technology helps assign the ownership of the original piece.”

Selling NFTs has been a lucrative business in the art world. Here are a few examples you may have heard about:

  • Digital artist Beeple sold “Everydays – the First 5000 Days” for $69.3 million through a Christie’s auction.
  • A 20-second video clip of LeBron James “Cosmic Dunk #29” was sold for $208,000.
  • A CryptoPunk NFT sold for $1.8 million at Sotheby’s first curated NFT sale.
  • Twitter CEO Jack Dorsey auctions an NFT of his first tweet, which sells for $2.9 million.

Other people may be able to make copies of the image, video, or digital item that you own when you buy an NFT. But, similar to buying a unique piece of art or limited-series print, the original could be more valuable.

How NFTs work

Many NFTs are created and stored on the Ethereum network, although other blockchains (such as Flow and Tezos) also support NFTs. Because anyone can review the blockchain, the NFT ownership can be easily verified and traced, while the person or entity that owns the token can remain pseudonymous.

Different types of digital goods can be “tokenized,” such as artwork, items in a game, and stills or video from a live broadcast – NBA Top Shots is one of the largest NFT marketplaces. While the NFT that conveys ownership is added to the blockchain, the file size of the digital item doesn’t matter because it remains separate from the blockchain.

Depending on the NFT, the copyright or licensing rights might not come with the purchase, but that’s not necessarily the case. Similar to how buying a limited-edition print doesn’t necessarily grant you exclusive rights to the image.

As the underlying technology and concept advances, NFTs could have many potential applications that go beyond the art world.

For example, a school could issue an NFT to students who have earned a degree and let employers easily verify an applicant’s education. Or, a venue could use NFTs to sell and track event tickets, potentially cutting down on resale fraud

What’s the difference between NFTs and cryptocurrency?

NFTs and cryptocurrencies rely on the same underlying blockchain technology. NFT marketplaces may also require people to purchase NFTs with a cryptocurrency. However, cryptocurrencies and NFTs are created and used for different purposes.

Cryptocurrencies aim to act as currencies by either storing value or letting you buy or sell goods. Cryptocurrency tokens are fungible tokens, similar to fiat currencies, like a dollar. NFTs create one-of-a-kind tokens that can show ownership and convey rights over digital goods.

How to buy an NFT

You can buy, sell, trade, and create NFTs from online exchanges or marketplaces. The creator or current owner may choose a specific price. Or, there may be an auction, and you’ll have to bid on the NFT.

  • Foundation: A community-curated marketplace that requires creators to be invited by other creators who are already part of the platform.
  • Nifty Gateway: An art-focused marketplace that works with big-name brands, athletes, and creators.
  • OpenSea: One of the first and largest marketplaces where you can find NFTs for a wide-range of collectibles.
  • Rarible: Offers a range of NFTs with an emphasis on art. Uses its own RARI token to reward members.
  • SuperRare: A marketplace that focuses on curating and offering digital art.

The sign-up process can vary depending on the marketplace. Generally, you’ll buy NFTs using a cryptocurrency, such as ether (Ethereum’s native cryptocurrency), although the price may also be listed in dollars. Depending on the marketplace, there may be different fees associated with each transaction.

The financial takeaway

While there may be many practical applications for NFTs in the future, they’re primarily used with digital art today.

“For creators, NFTs create a seamless way to sell digital art that might not have much of a market. Additionally, there are ways in which creators can get paid fees for each subsequent sale of the art,” says Ceesay. “On the flip side, collectors are able to speculate on digital art as well as have bragging rights on rare collectibles on the chain.”

If you’re considering purchasing an NFT as an investment, know that there’s no guarantee it will increase in value. While some NFTs sell for thousands or millions of dollars, others may remain or become worthless.

Investing in collectibles: 5 types of collectibles that have historically offered bankable returnsCryptocurrency is an electronic, private type of money – here’s how it works and how you can invest in itHow to invest in bitcoin: The major ways to buy, their pros and cons, and the strategies to considerAlternative investments are exotic assets that can diversify your portfolio

Read the original article on Business Insider

What is a shareholder? Understanding the rights that come with owning stock of a company

Executives huddled during a meeting to make a joint decision.
Shareholders can sue a corporation if there are wrongdoings from its directors that aren’t in line with their fiduciary duty.

  • A shareholder is an individual or entity that holds shares or stocks in a company.
  • Owning shares or stocks of a company entitles investors to partial ownership of a specific company.
  • Shareholders may receive dividends and have limited liability if the company is in hot water.
  • Visit Insider’s Investing Reference library for more stories.

When you invest in public companies, you purchase shares of the company’s stock. Each share of stock you own reflects a small portion of ownership of the company, making you a shareholder.

What is a shareholder?

A shareholder can be an individual or entity – such as a company or organization – that owns stocks in a particular company. If you invest in the stock market, you’re already considered a shareholder, or what is also referred to as a stockholder.

Shareholders, as part owners of a company, also have the right to vote in some cases regarding matters of the company and can receive dividend payouts when the company is doing well financially.

“A shareholder is one who owns a share of stock in the company. As long as he or she has that ownership, the shareholder has certain rights and obligations afforded to him or her by law through the corporation’s articles of incorporation and bylaws,” explains Jenna Lofton, who has an MBA in Finance and is the founder of StockHitter.com. “The rights of a shareholder are many, and include the right to attend shareholders’ meetings and vote in proxy elections. A shareholder also has the right to see corporate records, inspect the corporation’s premises, receive notice of stockholder meetings, and be paid dividends.”

Understanding how shareholders work

Shareholders work by providing money upfront to companies as part of their investment.

You can become a shareholder by investing in a publicly traded company. In exchange for providing capital, shareholders are offered certain rights to vote and make decisions about the company.

While it’s possible to invest in private companies to become a shareholder, that process is different as it involves working directly with the company, rather than through the stock market.

A company may already be public and traded on the stock market, or a company may go from private to public with an initial public offering (IPO).

To get started, individuals can invest in company stock through their brokerage account and a brokerage firm by using the company’s ticker symbol, which you can find using a search tool.

Companies must file reports with the Securities and Exchange Commission (SEC) to keep shareholders updated on certain matters. For example, annual reports and quarterly reports are filed to share financial information and updates with shareholders.

There may also be additional disclosures about mergers or other important events that affect a company as well as proxy statements. Proxy statements share information about the company as part of the shareholder voting process. You can review many of these documents on the SEC’s EDGAR website.

“One of the most important rights of the shareholders is their voting power as it allows them to influence management composition. Shareholders elect the board of directors who manage the company and appoint the company CEO, explains David Clark, lawyer and partner at The Clark Law office. “Their ownership of the company is also protected by law by giving them preemptive rights or the right to purchase company shares before these are offered to the public.”

Shareholders have residual rights, which means they’re entitled to a portion of a company’s profit, even if the company goes under. The SEC states that residual profits must be distributed to shareholders proportionally, based on their percentage of ownership through shares.

“Shareholders do not actually manage the corporation. However, the law gives them the responsibility of making sure that the company is well-managed through their voting powers, power to declare dividends, and approval of the company’s financial statements,” says Clark. “In case of insolvency, they have the responsibility to pass a resolution for voluntary liquidation to wind up the company’s operations.”

Shareholder rights

Shareholders of a company are entitled to certain rights as well.

Economic rights. Shareholders invest in companies to get returns on their investment through economic gains. Shareholders are entitled to profits of a company that they invest in through dividend payments or being able to sell stock at will. Additionally, if a company goes under, shareholders are entitled to net proceeds of the company after it’s dissolved according to Delaware Code § 281(a).

Control rights. Shareholders have the right to vote on matters that relate to the business, including electing directors, which offers some control and influence without actually managing the business itself. Shareholders will also typically receive proxy statements via email from their broker. If a shareholder doesn’t vote, brokers still may be able to vote on their behalf by something called uninstructed voting – but only on routine matters. But in light of new legislation passed in 2010 through the Dodd-Frank Wall Street Reform and Consumer Protection Act, limits were placed on this type of voting requiring the New York Stock Exchange (NYSE) and Nasdaq to prohibit voting executive compensation as well as electing board members.

Information rights. Shareholders are entitled to some information about the company you invest in when you’re a shareholder. For example, you may be entitled to financial statements. Investors may also receive information on board meeting minutes and inspect articles of incorporation if requested in writing with five day’s advance notice. It’s possible to review a list of shareholders as well as basic documents such as the charter and bylaws. To receive additional information when it comes to inspecting articles of incorporation or the books, investors must show that their request is legitimate and with a purpose.

Litigation rights. Shareholders have the right to sue the corporation if there are wrongdoings from its directors that aren’t in line with their fiduciary duty. Though investors can’t sue for just any reason, if there are violations it’s possible to sue with a direct lawsuit or a derivative lawsuit.

“The Corporation Law grants common shareholders the right of ownership, power to vote, right to dividends, right to transfer ownership, right to sue, and right to inspect documents of the corporation,” explains Clark. “Preferred shareholders have priority rights when it comes to the distribution of profits as against the common shareholders, so they are entitled to fixed dividend rates. However, they do not enjoy the right to vote over executive decisions.”

Pros Cons
  • Can benefit from gains, or capital appreciation
  • May receive dividends
  • Shareholders may have voting rights on important matters
  • Has limited liability
  • There can be losses at any time
  • Not all companies pay dividends
  • If company goes bankrupt, you may receive nothing
  • Shareholders have limited rights

Types of shareholders

When you invest in a stock, you become a shareholder or stockholder – the terms refer to the same thing, which is owning a portion of the company through shares of stock. The two basic types of shareholders are:

1. Common shareholders. This type of shareholder owns part of a company through common stock and has voting rights as well as potential dividend payments.

2. Preferred shareholders. This type of shareholder doesn’t have the same voting rights and is more rare. A major difference is that they have priority over dividend payments over common shareholders.

Shareholders vs. bondholders vs. stakeholders

There are some differences between shareholders, bondholders, and stakeholders to be aware of.

  • Shareholders own a portion of a company by investing in their stocks and are sometimes referred to as a stockholder – because you hold stock.
  • Bondholders can buy corporate bonds to lend money to a company and in return get interest on the investment. As the bond matures, you’ll be repaid your principal investment. Unlike a shareholder, you don’t own a portion of the company and are only eligible to receive interest on the bond as well as your principal.
  • Stakeholders is a term that refers to a larger group of people that have an interest in a company’s outcomes. Stakeholders can include employees, shareholders, customers, and more. Stakeholders can mean anyone who has a stake in the company, which is different from a shareholder who specifically owns shares of the company.
Shareholders Bondholders Stakeholders
  • Own shares of a company in the form of stock
  • May pay out dividends
  • Owns bonds that lend money to companies
  • Pays out interest and principal
  • Can refer to anyone who has a stake in the company
  • Stakeholders can also be shareholders as well as employees and customers

The financial takeaway

As a shareholder, it’s possible to own shares – or portions of ownership – of a public company. You can become a shareholder or might be one already if you invest in the stock market. As with anything in the stock market, there is the potential for great reward but also great risk that can come with losses.

You may have certain rights that you can take advantage of as well, such as voting, and potentially have access to dividend payments. To help you manage as a shareholder, it’s always a good idea to check out reports from the SEC to see how a company is doing so that you can be an informed investor.

What are fractional shares and how do they work?How to invest using dollar-cost averagingWhat is the Securities and Exchange Commission?Floating stock: Why it’s important for investors to know a company’s float

Read the original article on Business Insider

Market order vs. limit order: What’s the difference?

Market Order vs Limit Order, divided by an upwards trending arrow on investing themed background
Most major online platforms don’t charge any commission for a market or a limit order, although investors who use a live broker or buy a thinly traded stock may pay a fee for a limit order.

  • A market order is an order to buy or sell a security immediately, guaranteeing an execution but not a price.
  • A limit order is an order to buy or sell a security at a specific price, or better, and isn’t guaranteed to be executed.
  • Each of these order types give investors more control over their money, but they do have their drawbacks.
  • Visit Insider’s Investing Reference library for more stories.

Other than actually selecting specific securities to buy or sell, one of the biggest decisions that investors make is how to get the trade done: with a market order or a limit order. These two order types tell your broker exactly how to execute your trade – selecting the right order type can save you money, or help you snatch up more money on your trade.

Market order vs. limit order: At a glance

Market and limit orders can give investors an added layer of flexibility in their trading decisions. Market orders generally let them quickly execute a buy or sell, while a limit order can ensure that they don’t pay too much for a security, or sell it for too low of a price. Here are the two order types in a nutshell:

  • A market order is an instruction to buy or sell a security immediately, regardless of the current price.
  • A limit order specifies an upper or lower value for a buy or sell transaction.

Let’s take a closer look at each of these order types.

What is a market order?

A market order is an instruction to buy or sell a security immediately. It guarantees that the order will be executed, but does not guarantee the price since the prices of securities are always changing – even as you place your order.

A market order to buy assets generally will execute at or near the current bid – what an investor is willing to pay for to buy the security – while a market sell order usually executes close to the current ask, or the price at which the owner of the security is willing to sell.

But it’s important to remember that the most recently traded buy or sell price may not be the same as your execution price, particularly if the individual stock or the broader market is volatile. “The volume of market orders tends to outpace limit orders,” says Bryan Kuderna, CFP® and founder of Kuderna Financial Team. But it’s not unusual to see an uptick in limit orders during periods of volatility.

Pros Cons
  • Order executes immediately
  • Usually executes at most recent price
  • Will not trigger excess fees
  • Possible pricing surprise

What is a limit order?

A limit order is one type of order that lets an investor set a cap (or “limit”) on the maximum per-share amount they’re willing to pay for a security – or the minimum amount they’ll accept on a sale. Think of it as a kind of fence around the price – a buy limit order or a sell limit order offers individuals more control over their investments. On the buy side, a limit order can only be executed at or below a price set by the investor. On the sell side, the transaction can only go through at a price that’s equal to or higher than the amount set by the investor.

“A limit order gives the investor some control of the price at which they add or remove securities from their portfolio, particularly for volatile stocks,” Kuderna adds. “The pitfall here is that if the security moves in the wrong direction, the investor can miss out on the desired buy or sell price as the order won’t take place.”

So a buy-side investor may try to shave a bit off the current market price with a limit buy order, but miss the boat completely if the stock takes off. On the sell side, someone who wanted to hold out for even a few cents more than the current market value could get stuck with a lemon if the stock price plunges.

While a limit order can be useful in controlling how much you pay for a stock, it doesn’t come without its drawbacks. “[Limit orders] can be more complicated to execute, particularly for thinly traded stocks,” says Kuderna. “This can sometimes result in higher fees and/or specific orders actually not taking place if there’s not enough liquidity in the market when the order is triggered.”

Pros Cons
  • Offers control over price
  • Can be used to buy or sell orders
  • You can add conditional orders for more control over your execution
  • Your order may not be executed if target price isn’t met
  • May be more complicated and incur extra fees
  • Orders may be partially filled

The financial takeaway

Market and limit orders are two types of orders that investors can use to better control how they invest their money and at what price. But these two options do come with some downsides.

The choice of a market order or limit order will depend on the specific circumstances of your trade. Generally, if you aren’t worried about not getting a specific price, a market order will go a long way towards ensuring that your transaction gets executed in a timely manner.

But if you’re concerned about a specific price, a limit order probably makes more sense, since the transaction won’t occur unless you get your price. But it could take longer and you could miss the boat on a fast-moving stock or a volatile market. Before going with a market or limit order, consider how these and other related issues fit into your investment strategy.

What is a stop order?What is a limit order?What is a put option? Understanding how to trade themWhat is a call option?

Read the original article on Business Insider

Ex-dividend date: Why it’s important to know when investing in dividend stocks

Woman on the phone in the city checking the time.
The ex-dividend date is important to dividend investors because of the role it plays in determining who gets the next dividend payment.

  • The ex-dividend date, or ex-date, marks the cutoff period in which you can purchase a stock to receive the upcoming dividend payment.
  • If you own shares the day before the ex-dividend date, you receive the next dividend payment. If not you purchase the stock on the ex-date or after, the seller gets the dividend.
  • Investors use the ex-date to decide between receiving the upcoming dividend at full share price or giving up the dividend for a discounted share price.
  • Visit Insider’s Investing Reference library for more stories.

Investors looking for ongoing income from their investments often buy stock in dividend-paying companies for the earnings distributions they receive. To maximize profits, these investors must pay close attention to several important dates, one of which is the ex-dividend date.

When a company declares a dividend, a process is set in motion with precise rules about how those dividends will be disbursed and to whom. Here we will learn about that process and the role played by the ex-dividend date.

What is an ex-dividend date?

The ex-dividend date of a stock determines who receives an upcoming dividend payment. If you own shares of a dividend-paying stock the day before the ex-dividend date, you’re entitled to the next dividend payment. If the stock is bought on the ex-date or any time after, the dividend payment is collected by the seller.

Another very similar-sounding term you might hear is ex-dividend. This is not the same as the ex-dividend date.

Ex-dividend refers to a stock that trades without the value of the next dividend payment. A stock is ex-dividend if it trades on or after the ex-dividend date. If you buy a stock after it has gone ex-dividend, you will own the stock but will not get the next dividend payment for that stock. Instead, the payment will go to the person who sold you the stock.

Why is it important?

Dividend investing is a system that involves buying stocks that pay a portion of the profit the company has earned on a regular basis, called dividends. Dividend investors typically use a buy-and-hold strategy in which they buy reliable stocks in solid companies and collect the dividends over a long period, buying or selling only when they want to add new stocks or dump stocks that are no longer performing.

The ex-dividend date is important to dividend investors because of the role it plays in determining who gets the next dividend payment. If you own a stock and want to make sure you get the next dividend payment, don’t sell the stock until the ex-dividend date or later. If you buy a stock and want to make sure you get the next dividend payment, buy the stock before the ex-dividend date.

How ex-dividend dates work

The process begins when a company declares it will pay a dividend. As part of that declaration, the company states how much it will pay (dividend) along with four important dates including the declaration date, ex-dividend date, record date, and payment date.

But first: To completely understand the role of the ex-dividend date you should know four dates that are part of the dividend payment process. The US Securities and Exchange Commission (SEC) regulates the dates that relate to dividend payments.

  • Declaration date: This is the date the company declares it will pay a dividend, how much it will pay, when it will pay it and, importantly, the ex-dividend date. By regulation, the declaration date must be at least 10 business days before the record date.
  • Ex-dividend date: This is the cutoff date to decide who gets the next dividend payment. If you own the stock one business day before the ex-dividend date, you get the payment. If somebody else owns the stock on that date, they get the payment. Two methods are used to determine the ex-dividend date, which we cover below.
  • Record date: This date is set by the company as the date it will determine who the stockholders of record are. These are the stockholders who will receive the upcoming dividend payment.
  • Payment date: This is the day the company pays out the dividend.
  • Settlement date: This is the date you actually own the stock if a buyer or receive payment if a seller. Stock settlement typically happens two business days after the order is placed.

The ex-dividend date acts as a buffer to make sure there’s enough time to complete a transfer of stock ownership from the seller to the buyer. This is why in order to receive the upcoming dividend payment you must buy the stock before the ex-dividend date.

Let’s take a look at two examples of how the ex-dividend date is used with the following dates:

Declaration date Ex-dividend date Record date Payment date
7/29/2021 8/12/2021 8/13/2021 9/17/2021

On July 29, 2021, Company XYZ announced a $2 quarterly dividend payout to shareholders. The company declared a dividend payment date of September 17, 2021. The date of record for shareholders on the company’s books is August 13, 2021. This means the ex-dividend date, one business day before the record date, will be August 12, 2021.

Example 1: On August 11, 2021, you purchase 100 shares of XYZ stock at $50 for $5,000. Since you initiated the purchase before the ex-dividend date, and assuming settlement occurs two business days later, you’ll be the shareholder of record on the record date (8/13/2021) and you will receive a dividend payment of $200 ($2 x 100 shares) on 9/17/2021.

Example 2: On the other hand, if you wait just one day and initiate the purchase on August 12, 2021, settlement will not occur until Aug. 14, 2021, meaning the person you bought the shares from will be the owner of record on Aug. 13. However, instead of paying $5,000 for the stock you will pay $4,800 ($5,000 – $200) since the stock would be trading ex-dividend.

An investing strategy: Dividend capture

According to Marc Lichtenfeld, chief income strategist at the Oxford Club, “Dividend capture is a strategy where an investor buys the stock before the ex-dividend date and sells on or right after the ex-dividend date in order to capture the dividend.”

The idea is to purchase the stock, “capture” the dividend, and sell the stock on or after the ex-dividend date at no loss or a slight gain, keeping the dividend as profit. Advocates of dividend capture strategy sometimes use ex-dividend date tracking tools to search for stocks that are going ex-dividend during a specific date range.

The more advanced tools offer additional information and analysis for a fee. There’s a tool sponsored by NASDAQ that provides all the basic information, including declaration (announcement) date, ex-dividend date, record date, payable (payment) date, dividend amount, and more for free.

When it comes to actually using dividend capture as a strategy, Lichtenfeld is not much of a fan. “The strategy doesn’t work,” he says. “If it did, large institutional investors would do it consistently and capture dividends every day.”

Lichtenfeld says the strategy doesn’t work because of that rule requiring stocks to go down by the amount of the dividend on the ex-dividend date. This, Lichtenfeld believes, creates “too much risk that the stock would fall as much as the dividend paid or more.”

This risk analysis doesn’t stop others from using the strategy to try to capture dividends as a way to make money. Capture advocates count on other factors to keep the price of the stock from falling, including positive earnings, economic factors, analysts expectations – and even rumors.

The financial takeaway

Since the ex-dividend date determines who gets the upcoming dividend based on who owns the shares the business day before that date, it’s one of the most important dates to track for dividend investors.

Some investors employ the use of dividend capture, which is a strategy where an investor buys and holds a stock just long enough to get the next dividend, then sell the stock quickly for no loss. This is risky since the price of the stock is automatically reduced by the upcoming dividend.

Remember that if you wait until the ex-date or later to buy stock, you will get it cheaper, just without the next dividend. Some investors prefer the discount more than they do missing one dividend payment.

Stock trading: How to get started for beginnersWhat are fractional shares and how do they work?Understanding buy-and-hold investing – a long-term strategy that Warren Buffett swears byA company’s earnings per share can help you gauge its profitability – here’s how you calculate it

Read the original article on Business Insider

Index funds vs. mutual funds: What’s the difference?

Mutual fund vs index fund, divided by an upwards trending arrow on investing themed background
Mutual fund refers to the structure of a fund, while index fund refers to a fund’s investment strategy.

  • Index funds and mutual funds let you invest in a variety of stocks, bonds and assets without having to cherry-pick your investments.
  • While mutual funds are actively managed by an investment professional, index funds are more passive, making them good for hands-off investors wanting steady returns.
  • Mutual funds come with much higher fees than index funds, which can cut into your potential gains.
  • Visit Insider’s Investing Reference library for more stories.

For many beginning investors, the idea of hand-picking stocks can probably seem quite daunting. Fortunately, with tools like index funds and mutual funds, that type of legwork isn’t actually necessary to start your investing journey.

Here’s what you need to know about these investment vehicles – and when you might want to invest in them.

Index fund vs. mutual fund: at a glance

Both index funds and mutual funds allow you to invest in a variety of assets without having to cherry-pick those investments one by one. The major differences are how those funds are managed and their earning potential.

Here are the basics of both types of funds:

  • An index fund is a pool of investments that aims to mimic the performance of a certain market index – often the S&P 500, the Dow Jones Industrial Average or the Nasdaq Composite (though there are many more.) Investors buy shares in the fund and see gains when stocks within the fund grow in value.
  • A mutual fund is a company or fund that invests in a variety of assets, including stocks and bonds. Investors can then purchase shares of the fund, thereby purchasing a stake in all companies within that portfolio. Unlike index funds, mutual funds are actively managed, meaning a professional monitors the portfolio’s performance and regularly makes buys and trades within it.

According to Matthew Willett, an investment advisor at WealthPlan Advisors in Scottsdale, Ariz., both funds offer baskets of securities, which investors can then buy shares of.

“Instead of buying shares of many individual companies, investors can purchase shares of a fund made up of hundreds or thousands of companies,” Willett says. “As the companies within the fund either increase in share price or decrease, the value of investors’ shares in the fund will change in conjunction.”

Index fund

An index is a type of mutual fund or ETF that aims to match the returns of a certain index. The S&P 500 is one of the most commonly used indices, but there are many others, too, including the Wilshire 5000 Total Market Index, the Russell 2000 Index, and the Dow Jones Industrial Average.

With an index fund, money is invested into securities within the aligned index – sometimes all of them, sometimes just a sampling. The ultimate goal is to mirror the performance of the overall index and deliver similar returns to the fund’s investors.

Investors usually gain a small percentage annually. According to 2020 data, the S&P 500 returned 13.6% annually over the last 10 years. Historically, annual returns have averaged 9.2%.

Because index funds don’t require regular trading or selling, they’re considered passive investments, and they aren’t actively managed by a professional. This means fees are smaller on these funds than on other investment vehicles – particularly when compared to actively managed mutual funds.

“An index fund would be best for someone who did not have a lot of money and was just starting to invest,” says Josh Simpson, vice president of operations and investment advisor with Lake Advisory Group. “This would allow them to achieve diversification with their investment without having to spend hours learning how to invest.”

Pros Cons
  • Lower fees than mutual funds
  • Allows you to diversify across many companies and sectors
  • Slow but dependable returns over time
  • Requires minimal research or investing know-how
  • Not actively managed by a professional
  • No choice in who you invest in, which could be challenging if you take issue with a company’s business practices
  • Short-term gains are limited because you’re only invested in very small shares of each stock

Mutual funds

Mutual funds, like index funds, invest in a variety of stocks, bonds, and other assets, only they’re not trying to track the market – they’re trying to beat it. Mutual funds come in several types, including money market funds, bond funds, target date funds, and stock funds (index funds fall into this category.)

The majority of these funds (aside from index funds) are actively managed, which means an investment professional will sell and purchase shares within the portfolio regularly in an effort to maximize returns. While this does open the door for higher potential gains than index funds, it also means returns are unpredictable.

“The reason someone would choose an actively managed mutual fund is that if one can identify a fund manager that can consistently beat the market, one can accrue tremendous wealth,” says Robert Johnson, chairman and CEO of Economic Index Associates and a professor of finance at Creighton University. “For instance, investors who invested in the Fidelity Magellan fund during the time period Peter Lynch managed it earned an average of 29.2% during his time running it – more than twice what the S&P 500 earned during that time.”

Those kinds of gains aren’t guaranteed, though. And in many cases, actively managed funds actually underperform the market. According to data from the S&P Dow Jones Indices, 82% of large-cap funds underperform the S&P 500 over a 10-year period.

Pros Cons
  • Allows you to diversify across many companies and sectors
  • Could allow for higher gains, but only if managed well
  • Several types of mutual funds to choose from
  • Higher fees than index funds
  • Requires more research to find the right fund (and fund manager)
  • Riskier than index funds, as managers often try to beat the market

The financial takeaway

Both index funds and mutual funds can help you achieve your financial goals, but through very different approaches. With one, you’ll enjoy passive, hands-off investing that offers steady returns. With the other, you’ll get an actively managed fund that could, in some cases, beat the market.

If you’re not sure which is best for your goals, speak to a financial planner. In many cases, both investment vehicles may be the right choice for your long-term wealth.

What are the safest investments? 7 low-risk places to put your money – and what makes them soA comprehensive guide to investing in stocks for beginnersHow to buy a stock: A step-by-step guide to help you get started investingHow to buy treasury bonds, one of the safest ways to invest for income

Read the original article on Business Insider

How to invest using dollar-cost averaging

An extended hand holding out five fanned out one-dollar bills.
Investing regularly in your 401(k) each month is another example of using the dollar-cost averaging strategy.

  • Dollar-cost averaging is an investment strategy that can help you pay less for investments and better manage risk.
  • Instead of investing in a security all at once, dollar-cost averaging is the process of investing a fixed dollar amount at regular intervals over a long period of time.
  • ​​Dollar-cost averaging may underperform lump-sum investing in certain cases.
  • Visit Insider’s Investing Reference library for more stories.

Investing is all about managing risk and reward. The stock market is well-known for its ups and downs and trying to “time the market” can be difficult, especially if you’re just getting started with investing.

Instead of trying to time the market, there’s an alternative strategy that can be beneficial for investors at all levels: dollar-cost averaging.

What is dollar-cost averaging?

Dollar-cost averaging is the process of spreading out an investment purchase by investing equal dollar amounts at regular intervals. Instead of buying a stock or fund all at once, dollar-cost averaging involves portioning the purchase out over time.

The amount you invest, as well as how often you do so, can vary depending on the investor. By consistently putting money into the same investment over a period of time, you’re able to buy more during the dips and buy less when prices are high – basically leveling things out and reducing risk amongst any volatility.

“Dollar-cost averaging is an investment strategy that basically helps smooth out the cost of investing and minimizes the associated risk of trying to time the market,” explains Sabrina LaFleur, lead planner and CFP® at LearnLux.

Dollar-cost averaging vs. market timing

Dollar-cost averaging is a way for investors to continue to put money into the market despite market conditions. Through dollar-cost averaging, investors put the same amount of money at regular intervals (monthly, quarterly, etc.) in order to build wealth over time.

Instead of focusing on the ins and outs of “timing the market,” or making predictions on price movements, dollar-cost averaging is about consistently putting money into the market despite any gains or volatility.

Dollar-cost averaging Market timing
  • Means investing set amounts at regular intervals
  • Can remove emotion from investing
  • Focus is on consistency and disregards market performance
  • May delay investments based on market conditions
  • May lead to regret or procrastination
  • Focus is on adding money at the right time, and can lead to higher returns – or losses

How dollar-cost averaging works

Dollar-cost averaging has two components:

1. The fixed amount you invest

2. The regular interval you invest that amount

“The way it works is you purchase a fixed amount of the same investment in strategic intervals, like $100 on the first of each month. When you continue the strategy over an extended period of time, you should find that you’re able to purchase more shares with that $100 in some months than in other months because the price of shares will likely have fluctuated during your investment period,” notes LaFleur.

You could be utilizing dollar-cost averaging already and not even be aware of it. For instance, a common example of dollar-cost averaging is an employee who invests regularly in their 401(k).

Dollar-cost averaging works because it’s about consistently funding your investments and putting money into the market, rather than holding back and attempting to time the market. “It’s probably the most effective strategy for all investors at all levels. It’s one of the best ways to set it and forget it but you do want to pay attention to what you’re investing in,” says LaFleur.

Examples of dollar-cost averaging

First scenario: Let’s say you want to spread out $300 and invest $100 over three months. If you want to invest in a security that’s trading at $20 per share, you’d be able to purchase five shares in one month for $100. The next month, when you have another $100 to invest, the price soars to $50 per share and you’d be able to purchase only two shares. After a market drop the third month, the price is down to $10 per share and you’d be able to buy 10 shares. In a three-month period, you’d invest $300 and have 17 shares. Here’s a breakdown:

Time Amount invested Share price in the market # of shares bought that month Total shares
Month 1 $100 $20 5 5
Month 2 $100 $50 2 7
Month 3 $100 $10 10 17

In this example, even with price fluctuations over the three months, at $300 invested with 17 shares, your average cost per share is $17.6 ($300 ÷ 17 = $17.6).

If you were to sell in month four at a $20 share price (the same price as month 1), you’d sell your 17 shares for $340, with a profit of $40. If you were to sell in month 4 at a $40 share price, you’d sell your 17 shares for $680, making a profit of $380.

17 shares (total shares) X $20 (share price) = $340 (sell value) – $300 (total investment) = $40 (profit)

17 shares (total shares) X $40 (share price) = $680 (sell value) – $300 (total investment) = $380 (profit)

Second scenario: If you choose to go with the lump-sum investing strategy and chose to invest $300 in that first month at $20 per share, you’d have 15 shares. That’s two fewer shares you’d have compared to consistently putting money into the market. In this example, dollar-cost averaging would beat a one-time lump sum investment. On top of that, your average cost per share is a few dollars lower as well ($17.6 vs. $20).

In this case, if you were to sell in the month four at $20 share price, you’d sell your 15 shares for $300, effectively breaking even and not making a profit. If you were to sell in month 4 at a $40 share price, you’d sell your 15 shares for $600, making a profit of $300.

15 shares (total shares) X $20 (share price) = $300 (sell value) – $300 (total investment) = $0 (no profit)

15 shares (total shares) X $40 (share price) = $600 (sell value) – $300 (total investment) = $300 (profit)

Amount invested Strategy Average cost per share Pros Cons
$300 Dollar-cost averaging $17.6
  • Lower average price by share
  • More sustainable
  • May lead to fewer returns
$300 Lump-sum investing $20
  • Higher amount for longer period of time, can lead to higher returns
  • Cost per share may be higher
  • Must have more saved to invest a lump sum

While dollar-cost averaging won out in this hypothetical scenario, that won’t always be the case. Yes, dollar-cost averaging is a good strategy in spreading your risk and lowering the average amount you pay for shares. But there’s a strong case for lump-sum investing, which exposes you sooner in the market and has been found to be more beneficial as a strategy.

In a study done by Northwestern Mutual, it found that lump-sum investing ​​generated better cumulative returns at the end of 10 years than dollar-cost averaging almost 75% of the time, regardless of asset allocation.

Using dollar-cost averaging, your cost-per-share may even out and be lower, but you may also get fewer returns as well. Through lump-sum investing, you may pay more per share but expose your money to the market which can lead to higher returns but also more risk. In this way, dollar-cost averaging may be a safer bet for people with a low risk tolerance.

Advantages of dollar-cost averaging

Dollar-cost averaging helps investors remain consistent in their quest to build wealth and can combat fear. When investors are fearful, it can lead to poor decision-making. So staying the course can help over the long-term and remove emotions from your decision-making.

“The upside is when the market is down the share price of the investments you’re purchasing are likely to be down as well, which means you’re buying it at a discount or when the shares are ‘on sale.’ This basically allows you to purchase more with your money without trying to time the market, which is often a losing strategy,” says LaFleur.

Dollar-cost averaging is helpful for investors who may not have as much money to invest. You may think you need thousands of dollars to get started with investing, but you don’t. While a lump-sum investor may use that strategy, using dollar-cost averaging, you can invest a smaller amount in regular intervals to build wealth over time.

Dollar-cost averaging is a good strategy for investors who may not have tons of cash to invest right away as well as for people who don’t want to concern themselves with the ups and downs of the market.

If your risk tolerance is low and you get nervous about shifts in the market, this could also be a good strategy to help you stay the course. Otherwise, you might sell in a panic and potentially lose out on important gains in the long run.

If you have a large sum of cash to invest or you’re investing for a specific goal over the short term, lump sum investing may be a good fit.

Disadvantages of dollar-cost averaging

As noted above, dollar-cost averaging may offer less in the way of returns than lump-sum investing in some instances. Additionally, when prices are high you may get less bang for your buck.

“The main disadvantage is that when the market is up the share price of the investments you’re purchasing are likely to go up as well which means you’re buying at a premium,” says LaFleur. “This is not necessarily a bad thing. This strategy ensures you’re still participating in long-term market growth by investing what you can regardless of market conditions instead of allowing emotion to drive your investment decisions.”

Another thing to consider is that through dollar-cost averaging you could end up dealing with more brokerage fees which could take a chunk out of your nest egg. Be sure to research fees and costs as part of your investment planning.

The financial takeaway

Investing can be an emotional process, no matter how much experience you have. Dollar-cost averaging is one investment strategy that can help minimize the anxiety around investing as you continue to put money in the market consistently, regardless if things are booming or tanking.

On top of that, it’s a good option for investors who are starting out with a little bit of money to get started with investing. Many people may not have a lump sum to get started investing, but you may be able to throw an extra $100 or more toward investing each month.

Just be aware of brokerage fees and your personal risk tolerance to help guide your investment decisions. As always, you can talk to a financial professional to find the best option for you.

What is compound annual growth rate?FINRA: The organization that regulates broker-dealers and protects investorsHow stock quotes can better inform your investing decisionsA comprehensive guide to investing in stocks for beginners

Read the original article on Business Insider

Floating stock: Why it’s important for investors to know a company’s float

Hand holding balloons with the word Stocks
High-float stocks are generally better for long-term investing strategies.

  • The float of a stock refers to the number of shares a company has issued for public trading.
  • A company’s stock float is calculated by subtracting the number of closely held and restricted shares from the number of total outstanding shares.
  • The number of floating stocks fluctuate over time and are influenced by various conditions in the market.
  • Visit Insider’s Investing Reference library for more stories.

Investing in the stock market is always a risk, which is why it’s important to thoroughly research any company and its stock before making any decisions. One piece of information you’ll want to pay close attention to is float, which is the number of shares a public company has available for trading.

Here’s a closer look at what floating stock is all about and how it can help inform your investing strategies.

What is floating stock?

Floating stock is the number of public shares a company has available for trading on the open market. It’s not the total shares a company offers, as it excludes closely held and restricted stocks. A stock’s float just tells you how many shares can be bought or sold at the present time.

Calculating a company’s floating stock is a simple matter of subtracting the number of closely held and restricted shares from the number of total outstanding shares. Closely held shares may be owned by employees, major shareholders, or insiders, while restricted shares are ones that are not allowed to be traded for a certain period of time, such as during the lock-up period after an IPO.

Understanding how floating stocks work

Because floating stocks are the number of shares available to the public for trading, they’re subject to fluctuations over time and are influenced by various conditions. They are usually categorized as high and low.

High float: A stock float is considered high if it has a large number of shares available for trading. In the example above, Samsung Electronics Co., Ltd.’s float would be considered high because the vast majority of the total stock is open for trading.

It also means that it’s easier for investors to buy and sell these stocks because there isn’t a lot of demand. High floating stocks are preferred by institutional investors, such as mutual funds and insurance companies, because they can buy large numbers of shares without influencing the stock price much.

Low float: When a small percentage of shares are available for public trade, it’s considered a low float. This may be the result of having a large number of closely held or restricted shares or having few investors. The supply of shares is low, which can make them difficult to acquire and discourage investment.

A float may increase when a company issues new shares as a way to raise capital. It can also decrease if insiders or major shareholders buy up shares or increase if they sell shares.

“A company’s float is an important number for investors because it indicates how many shares are actually available to be bought and sold by the general investing public,” says Tim Speiss, co-partner in charge of the Personal Wealth Advisors Practice with EisnerAmper LLP. “Low float stocks typically have higher [bid-ask] spreads and higher volatility than a comparable larger float stock.”

What are low-float stocks?

While there’s no industry-wide standard for what defines low floating stocks, Speiss says, many brokers consider stocks with fewer than 10 million freely available shares for trading to be a low float.

For example, Nortech Systems Incorporated currently trades on the New York Stock Exchange with 2.66 million outstanding shares. Of that, 1.16 million shares are floating. Only about 44% of this stock is available for public trading. The majority of this stock is owned by either major investors, employees, or company insiders, making it a low float.

Smaller floats like this are subject to large swings in value from news impacting a company’s finances, popularity of products, and other changes that can influence demand. According to Nasdaq, Sequential Brands’ low float stock experienced a 104.57% increase in price between July 1 and 6, 2021 in spite of reports bankruptcy may be around the corner for the company. Trade volume spiked from nearly 34,000 shares on July 1 to around 13 million on July 6. Just two days later, the stock price dropped 27% and trading volume slowed to 728,000 shares.

This kind of volatility can present opportunities to buy and sell shares to quickly make money, but it isn’t generally compatible with long-term investment strategies. Because the value of low float stocks can be so unpredictable, there can be considerable risk attached to investing in them. Also, low float stocks are in short supply, which can make it difficult to buy or sell them. The bid-ask spread may be much higher than you would find with a high-float stock as a result.

As mentioned before, companies may decide to increase their float by issuing new shares as a way to raise capital or encourage more trading. But they may also choose to reduce their float through a stock buyback, which can result in increasing the value of shares. This usually happens if the company believes its shares have been discounted too much, wants to invest in itself, or wants to see its financial ratios go up.

“A stock buyback is a way for a company to reinvest in itself,” Speiss explains. “The repurchased shares are absorbed by the company and the number of outstanding shares in the market is reduced. Because there are fewer shares on the market post buyback, the relative ownership stake of each investor increases.”

Evaluating low-float stocks

A few things to keep in mind when considering investing in a low-float stock include:

  • Relative volume (RVOL): This is a comparison of how the current trading volume measures up against trading volume in a previous period. This indicator is key because it can impact a company’s liquidity and tells investors whether a company is worth investing in.
  • Reactions to news: Has the volume or price of a stock been impacted by news relating to the company that issues it? If so, what was that change and how long did it last? How often is the stock influenced by such news? Answers to these questions can give you an idea about past performance and inform your opinion about what may happen in the future.
  • Float percentage: This is the total number of shares available for trading, expressed as a percentage. When considering float percentage, ask yourself: How small is the float and how long has it been that size? Has the company recently instituted a stock repurchase? Was there a stock split or reverse split? Look for reasons why the float is low and if it has historically been so. This can give you insight as to whether there is a good opportunity to invest or if you should pass on the stock.

Shares outstanding

Shares outstanding is the total shares of stock a company has. It includes the restricted and closely held shares, as well as the ones available for trade, whereas float refers only to the number of shares available for trading.

It’s important to look at and understand how much the total stock is so you can calculate whether the float is high, low, or in the middle. You can find outstanding shares and float statistics on most investing websites and indexes. Subtract the float from the outstanding shares to find how many shares are not available for trading. That will help you better evaluate what kind of float a stock has and whether investing in it might fit into your overall strategy.

The financial takeaway

The term floating stock simply refers to the number of shares available right now for trading. It doesn’t include restricted or closely held stocks – only what you can buy and sell in the public market. You can use this statistic when you evaluate whether or not you want to invest in a particular stock.

Generally speaking, high-float stocks are usually best for long-term investing strategies. If you’re looking for potentially substantial gains in a short timeframe, then low float stocks can be something to look into. As with all investments, there are risks with both. Make sure to do your research and consult with a financial professional before making any money moves.

What are stock options and how do they work?A comprehensive guide to investing in stocks for beginnersA company’s earnings per share can help you gauge its profitability – here’s how you calculate itHow to use ETFs to diversify your portfolio, trade more frequently, and invest safer

Read the original article on Business Insider

Stock trading: How to get started for beginners

Shaking hands trading stocks on blue background with yellow stock line 2x1
Trading requires a lot of time to follow the markets and spot opportunities to make a profit.

  • Stock trading involves buying and selling stocks for profits within a short time period.
  • Trading is a risky venture, and to do it successfully requires time and a deep understanding of the market.
  • Trade smarter by setting your budget, risk tolerance, and trading strategy ahead of time.
  • Visit Insider’s Investing Reference library for more stories.

We all want to be the next person to win big with a lucky stock trade. Unfortunately, this isn’t in the cards for most traders. In reality, it takes a lot of knowledge, research, discipline, and patience to become a profitable stock trader.

“Investing is not about getting rich quick. Investing is about getting rich slowly,” says Randy Frederick, vice president of trading and derivatives at Charles Schwab. These are wise words to live by if you’re new to the stock market and wondering if trading is right for you.

But if you’re curious about the so-called thrill of short-term buying and selling and the potential profits that can come along with it, here are the basics of stock trading and the steps that will help get you started.

What is stock trading?

Stock trading entails buying and holding stocks for a short period of time in order to turn a quick and significant profit. Traders aim to take advantage of short-term pricing fluctuations in the market.

Trading can be contrasted with investing, the approach to the stock market that aims to gradually build wealth by holding assets over a long period of time. Whereas investors buy stocks and hold them for many years, traders hold them for only an hour, a day, a week, or a few months.

There are two main types of stock trading: active and passive trading.

Active trading is a highly technical approach with the goal of capitalizing on short-term price fluctuations. Active traders are generally divided into two camps, based on the time period in which they hold their securities:

  • Day traders: Day trading refers to any strategy that involves buying and selling stock over a single day, such as seconds, minutes, or hours.
  • Swing traders: Swing trading involves buying securities and holding them for days or weeks.

Passive trading focuses more on stocks’ long-term trends, rather than short-term fluctuations or market news. Position trading is a type of passive trading.

Passive traders buy based on overall market trends, and sell when they believe the security hits its peak, which can take months. They generally trade less than active traders. In this way, passive traders are more akin to long-term investors who follow a buy-and-hold strategy.

What to know before you start trading

Stock trading is a tricky business. Yes, trading individual stocks can be exciting and profitable, but no one will tell you it’s easy. Here are a few things to keep in mind:

Successful trading takes time and commitment. If you’re just starting out in trading stocks, it’s best to avoid day trading and consider longer-term strategies. “Day trading is actually the worst option for beginner investors,” says Frederick. In reality, for every person who makes millions off of a lucky trade, there’s thousands of others who lost money trying the same tactic.

Whether you plan to trade full-time or part-time, the bottom line is trading requires a lot of time to follow the markets and spot opportunities. And when it comes to trading within short-to-medium timeframes, timing can often be everything.

Trading has tax implications. Don’t let the thrill of making a quick buck distract from your obligation to the IRS. It’s important to understand how taxes on trades could affect your tax bill.

When you sell your stocks for a profit, you are subject to capital gains tax. While profits on stocks held for more than a year get a special tax rate – meaning you’ll most likely pay lower taxes – profits on stocks held for less than a year are taxed at the same rate as your regular income.

Knowledge is power for trading safely. Instead of blindly pursuing “hot” stock tips from a neighbor or recommendations from Wall Street analysts, it pays to develop your own trading ideas. When you study historical stock movements and research an investment yourself, you’ll be able to ride market volatility or formulate an exit strategy with confidence.

Moreover, experts agree that one of the worst things you can do is let your emotions or bias influence your investing decisions. Excessive emotional trading is one of the most common ways investors damage their returns.

How to get started trading stocks

Now that you’re armed with the stock-trading basics, it’s time to get into the real deal. Just make sure you take your time to learn the ropes. “Dip your toe in,” Frederick says. “Don’t dive in.”

1. Open a trading account

You will need a broker to make trades, so you’ll want to find one that you like and trust. There are several brokers to choose from, each with their own specialties.

As you decide on a broker, choose one with the tools, features, and interface that best complement your trading style and know-how. Other things to consider are fee structures, on-the-go accessibility, stock analysis tools, and educational resources. In the end, beginner traders will want a firm that has a wide offering and that will be there when times get tough.

If you’re not sure where to begin, see our recommendations for the best stock trading apps.

2. Set your budget

Set a trading budget for yourself and stick to it. Frederick suggests that if you’re drawn toward shiny new investments or companies, allocate up to 1% or 2% of your investment budget toward those assets. You can start trading with just about any amount, but don’t touch money you might need in the short-term, like for mortgage payments or emergencies.

3. Learn the basic types of stock analysis

Generally, trading relies on “technical analysis,” or making decisions based on stock price and historical market data, rather than “fundamental analysis,” which involves evaluating a company and determining its true worth.

The goal of technical analysis is to analyze price movements of a security in an attempt to forecast future price movements. While a technical analyst may look at statistical trends and patterns with charts, a fundamental analyst will start with a company’s financial statements.

While the two styles of analysis are oftentimes considered as opposing approaches, it makes financial sense to combine the two methods to give you a broad understanding of the markets to help you better gauge where your investment is heading.

In short: Any time well spent learning the fundamentals of stock trading is time well spent.

4. Practice with a stock market simulator

As you begin improving your analytical skills, you can easily put them to practice. Give stock trading a try without putting real money on the line with virtual trading, or paper trading. Virtual trading allows you to test your trading skills in a low-stakes environment.

Reputable online programs include TD Ameritrade’s paperMoney, MarketWatch’s Virtual Stock Exchange, and Power E*TRADE.

5. Plan your first trade

Once you fund your brokerage account and you’re ready to place your first trade, it’s time to drum up a plan, which will help you maintain discipline and consistency as a trader.

A good trading plan typically outlines entry (buy) and exit (sell) points, informed by your skill level, risk level, and your overall goals. Keep in mind that every position you hold will most likely come with its own technical parameters – so keep in mind the time and effort you’ll need to give each stock the attention it deserves.

The financial takeaway

Stock trading isn’t for the faint of heart. There’s much to learn and determine before you even get to placing your first trade. Always remember that stock trading is a risky business where your money is always at stake. Stick to your strategy, and don’t let your emotions or overhyped stories get the best of you. Success isn’t guaranteed, but with patience and luck, you just might find yourself a stock-trading expert in no time.

When you buy through our links, Insider may earn an affiliate commission.

What is insider trading and when is it illegal?What is a limit order?How stock quotes can better inform your investing decisionsIs Robinhood safe? Experts weigh in on using the commission-free investing app

Read the original article on Business Insider

What is a call option?

Young businesswoman talking on cell phone while using laptop in an office.
Call option contracts are typically for 100 shares of the underlying stock named in the contract.

  • A call option is a contract that gives you the right but not the obligation to buy a specified asset at a set price on or before a specified date.
  • The cost of buying a call option is called the premium and it acts like insurance against major loss.
  • This important trait of call options lets you hedge your bet. The option versus obligation to buy the asset lets you wait and see.
  • Visit Insider’s Investing Reference library for more stories.

The simplest way to make money in the market is to buy a stock or other asset, wait for it to go up in price, and then sell it for a profit. Alternatively, you could buy an option, which doesn’t require you to buy the actual stock. That’s because an option is a contract that lets you decide whether to buy the stock now, buy it later, or not at all.

“The key to trading options safely is to be long – that is to buy options – rather than selling options,” says Robert R. Johnson, Professor of Finance, Heider College of Business at Creighton University. “When an investor buys an option the most they can lose is what they paid for the option. When someone sells an option they have a virtually unlimited liability if the price of the asset moves against them.”

Here we discuss one specific type of option – the call option – what it is, how it works, why you might want to buy or sell it, and how a call option makes money.

What is a call option?

A call option is a financial contract that, for a fee, gives you the right but not the obligation to purchase a specific stock at a set price on or before a predetermined date.

There are two types of options: call options and put options. Put options gives you the right but not the obligation to sell a stock at a set (strike) price on or before the expiration date. If you think a stock is going to go up before the expiration date, a call option lets you profit from the rise in price. If you think the stock is going to go down, a put option lets you profit from the fall.

Call options use special terms to refer to various components and actions:

  • Contract. A call option is a contract between you (buyer) and the seller (writer) of the option contract. Call option contracts are typically for 100 shares of the underlying stock named in the contract.
  • Premium. This is the fee you pay to purchase a call option contract. It’s a per-share amount you pay, similar to an insurance premium. The premium protects you from losing a large amount of money if things don’t go the way you expect.
  • Expiration date. This is the last day the option contract is valid and is set by the writer (seller) of the options contract. If you don’t buy the stock by then, the option expires worthless and you lose the premium you paid.
  • Strike price. The strike price is the price the seller agrees to sell a single share of stock for on or anytime before the expiration date.
  • In the money. When the current price of the underlying stock is above the strike price, the contact is said to be “in the money.
  • Out of the money. Conversely when the current price of the underlying asset is below the strike price, the contract is said to be “out of the money.”
  • At the money. As you might expect, this describes a contract in which the underlying stock price and the strike price are the same.
  • Exercise option. This is what you do if you decide to buy the underlying stock at the strike price on or before the expiration date.

How call options work

Owning a call option contract is not the same as owning the underlying stock. A call option contract gives you the right to buy 100 shares of the underlying stock for the strike price for a predetermined period of time until the expiration date of the contract.

This important trait of call options lets you hedge your bet. The option versus obligation to buy the asset lets you wait and see.

Things that may impact your decision to buy a call option could include the strike price; Is it too high? What about the premium? Would you be paying too much for your insurance? And what about the expiration date? Is it too far into the future – or too soon?

If your asset appreciates in value you can:

  • Exercise your option, buy the asset, sell it, and keep the profit.
  • Sell the option contract for its new higher value and keep the profit (premium).

If the asset stays the same or goes down in value you can:

  • Sell the option contract and recover at least part of the premium you paid.
  • Let the option expire worthless and lose the entire premium.

Fortunately, there are many options contracts available. Chances are you can find one that aligns with your own analysis of the stock or asset in question.

Why buy a call option?

The main reason people buy call options is to generate a profit on a stock they’re bullish on. Other factors include the following:

  • Low risk. Since you risk losing only the premium when you go long on a call option, this strategy offers a low-risk way to speculate on the underlying stock.
  • Leverage. With low risk also comes leverage. For the price of the premium, you can invest in 100 shares of stock for pennies on the dollar.
  • Hedging/stop loss. Buying a call option is a way to hedge your short position on the underlying stock. You can minimize the downside if the stock suddenly shoots up in value. This effectively turns your call option into a stop-loss instrument.
  • Portfolio/tax management. You can use options to change portfolio allocations without actually buying or selling the underlying stock. This could be part of a strategy to reduce your exposure to a stock you own with a large unrealized capital gain. Although gains from options are taxable, nothing is reported until the option is exercised, sold, or expires.

Why sell a call option?

If you own a call option there are three things you can do with it. Let it “expire worthless” and lose the premium you paid (although that’s all you lose); exercise your option to buy the underlying asset so you can sell it for a profit; or sell the option before it expires, also to turn a profit.

Here are some of the reasons you may want to sell your call option:

  • Make a profit. Over time, the underlying asset may rise in price which will, in turn, raise the premium (fee the seller would receive). You may choose to sell your option and pocket the profit from the increased fee you would receive.
  • Avoid loss. If the underlying asset remains steady or declines, you may decide to sell to recover at least part of your premium before the option expires worthless.
  • Avoid paying commissions. Even if you believe the stock will expire in the money the premium you receive for selling the option instead of exercising your option will let you avoid paying commissions that could negatively affect your profit.
  • Avoid risk of spillage. Spillage happens when you exercise your option, try to sell the underlying asset on the market, and don’t get what you expect.

Another way to sell a call option is to write your own. There are two main types of written call options, naked and covered.

Naked call option. This is when you write (create) a call option for underlying assets you don’t own. In this case, you’d write an option for a stock you think will not increase in price before the expiration date you set. A buyer thinks otherwise and pays you a premium for the contract you wrote. If the option expires worthless, you keep the entire premium as your profit.

If the value of the asset increases and you have to sell the buyer 100 shares at the strike price, and you lose the difference between the strike price and the amount you have to pay for the shares minus the premium.

Covered call option. A covered option is when you write a call option for an asset you already own. Your motivation is the same: You believe your asset will stay the same or decline by the expiration date. You sell the option to get the premium (fee paid by the buyer).

If the asset performs as you expected, you keep the premium and that helps to offset the loss in value of the asset you own. If the asset rises in value, you’ll need to hand it over to the buyer for the strike price. You’ll lose the gain you would have had if you still owned the asset, minus the premium you received.

When it comes to selling call options, however, Alexander Voigt, Founder and CEO of daytradingz, offers the following caveats: “Investors are often tempted to trade the so-called naked options because it appears attractive to collect the options premium. However, selling options without limiting the risk by hedging the options trade involves unlimited risk.”

“Unforeseen overnight price gaps caused by news catalysts like earnings announcements involve the highest risk,” he continues. “In addition, investors must be aware that the buyer of the call option has the right to demand the underlying stock at the strike price from the option seller prior to expiration.”

The financial takeaway

A call option is a contract to buy an underlying asset – not the asset itself. The contract gives you the right, but not the obligation, to purchase the underlying asset at a set price before a set date. For this right, you’d pay a fee or premium, similar to an insurance premium. This premium protects you in case the underlying asset doesn’t increase in value.

While it may all sound simple, options can be complicated. Buying a call option is considered a good entry point for anyone interested in beginning to trade options, but as with any type of investing, caution is advised. As always, seek the advice of a trusted financial advisor before starting any new type of investment.

Options let you lock in a good price on a stock without actually buying it – here’s how option trading worksWhat are stock options and how do they work?What are commodities? Tangible, everyday goods you can invest in, to hedge against inflation or sinking stock pricesWhat to know about derivatives and how they allow investors to hedge, leverage, and speculate

Read the original article on Business Insider