Stock Buying Basics

February 26th, 2009, by

Q: What happens if you buy 100 shares of a stock at $4, then the stock goes down to $2.50? Do you lose the stock or the dollar difference between $4 and $2.50?

A: Well, I’m a little worried about you buying stock shares without knowing the basics, which is clear from your questions. But it’s good that you are asking questions.

When you buy stock in a company, you become a shareholder, essentially an owner albeit with limited power. What you get back in relation to what you paid for the shares depends on the success or failure of the company.

You do not “lose” your stock shares, as you put it. The stock shares are always yours until you sell. What you lose—at least on paper—is the difference between the current share value and what you paid for the shares. You only lock in your losses when you sell. So for example, if you sold your stock shares for $2.50 after paying $4, your loss is $1.50.

However, if you hold on to the shares, they could go down further or go up, in which case you can realize the upside gain if you sell at that point.

I like that you are interested in investing, even considering the crazy gyrations of the stock market. But, for the average investor, many experts recommend you invest by buying shares in a mutual fund. Mutual funds have allowed millions of people to invest and enjoy the stock market without having to spend time picking stocks and without having to worry themselves gray tracking the daily ups and downs of their stock shares.

During normal market conditions (when we aren’t seeing heartbreaking drops every day), investment advisers generally recommend investing no more than 10% to 20% of an investment portfolio in any single stock. And, given the current state of the stock market, I would err on the lower side of that percentage rule.

When investing, it’s important to remember this one word: Diversification. What you don’t want to do is put all your money in one particular investment.

Diversification is an investment strategy for spreading your principal among different markets, sectors, industries and securities, explains the Financial Industry Regulatory Authority (FINRA), the largest non-governmental regulator for all securities firms doing business in the United States.

As FINRA points out, the goal is to protect the value of your overall portfolio, in case a single security or market sector takes a serious downturn and drops in price. In short, diversification means not putting all your eggs in one basket or one stock.

So, before you invest, I want you to go to FINRA’s Web site and do some research. Pay particular attention to the “Choosing Investments” section.

Last modified: April 26, 2011 at 10:59 am