Investing Unit 8: Buying Stocks

December 01, 2008 Print Friendly and PDF




Not too long ago, to build a diversified portfolio of stocks, you may have needed $30,000 to $50,000 or more. That was the cost to purchase a round lot of 100 shares of each of 10 or 12 different stocks at an average cost of $30 to $50 per share. Today, thanks to the popularity of investment clubs and the increase in both online trading and stocks that can be purchased directly from sponsoring companies, you can make a purchase for far fewer dollars. Making small stock purchases no longer has to be costly or embarrassing (e.g., asking a broker to trade a few shares), as it used to be. Direct stock investing today is easy and affordable.

As described in detail in Unit 9, Investing Resources, investment clubs generally assess members from $25 to $100 monthly, which is pooled to make club stock purchases. The amount of "dues" is decided by individual clubs based on the preferences of their members. Some investment club members also choose to invest additional dollars above the required amount. As for online trading (also discussed in Unit 9), some electronic brokerage firms require $1,000 or less to open an account, although a minimum of between $2,500 and $15,000 is typical. Stocks that can be purchased directly from participating companies often require initial investments of $1,000 or less, with subsequent investments (called OCPs or optional cash payments) of as little as $25.

Adequate diversification in a portfolio of individual stocks can, therefore, be achieved without spending a fortune. According to the National Association of Investors Corporation (NAIC), stocks can be grouped into 12 industry sectors. Consider the following example of an investment club stock portfolio that incorporates these sectors. The initial purchase of a diversified stock portfolio costs less than $3,000.

5 shares @ $35 of a building/forestry stock $ 175
5 shares @ $27 of a financial services company stock $ 135
5 shares @ $43 of a "consumer growth" (e.g., soft drink) stock $ 215
5 shares @ $51 of a "consumer staple" (e.g., food) stock $ 255
5 shares @ $39 of a "consumer cyclical" (e.g., car) stock $ 195
5 shares @ $62 of a technology (e.g., computer) stock $ 310
5 shares @ $48 of a capital goods (e.g., machinery) stock $ 240
5 shares @ $18 of an energy (e.g., oil) stock $ 90
5 shares @ $56 of a materials (e.g., paper company) stock $ 280
5 shares @ $73 of a transportation (e.g., air freight) stock $ 365
5 shares @ $21 of a utility (e.g., electric company) stock $ 105
5 shares @ $67 of a conglomerate company stock $ 335

In this example, the total cost of these shares is $2,700. Add on the fees that most companies with stock purchase plans charge (e.g., enrollment fees and fees to reinvest dividends or buy and sell shares) and the cost is undoubtedly higher, maybe $3,000.

Finding quality companies with affordable minimum investment amounts can be a challenge for individual investors, as well as investment clubs. It may also take several years to develop a diversified portfolio like the one described above if minimum amounts of $500 or more are required. Fortunately, the number of companies that allow investors to purchase shares directly has increased in recent years. Well over 1,000 companies offer shareholder investment plans where dividends are invested in additional shares. Of these, dividend reinvestment plans (DRIPs) allow investors to make direct stock purchases only after they acquire an initial share elsewhere. Some companies offer direct-purchase plans (DPPs or "no-load stocks") where even the first share of stock can be purchased from the sponsoring company.

In addition to their affordability, another advantage of DRIPs and DPPs is a discount on the price of shares, which can help stretch limited investment dollars. Approximately one in 10 companies that sell shares directly to investors offer a 3% to 5% discount on initial purchases and/or OCPs. Of course, the quality of a company, and not a discount on its stock, should be your primary consideration. If you’re picking a quality company, however, it’s nice to be able to purchase stock on sale. An increasing number of DRIPs and DPPs also allow investors to set up IRAs, although an annual fee of $25 or $50 is generally charged.

DRIPs and DPPs appeal to investors who are willing to do their own research rather than consult a broker. There are several helpful references available for investors who wish to learn more about purchasing stock directly from issuing companies. Among them are the books No-Load Stocks and Buying Stocks Without a Broker by Charles B. Carlson and the Web sites http://www.dripinvestor.com and http://www.dripcentral.com.

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This work is supported by the USDA National Institute of Food and Agriculture, New Technologies for Ag Extension project.