Pros & Cons of an Individual Stock Account

Pros & Cons of an Individual Stock Account

If you have some money to invest, one popular option is to set up an individual stock account with a brokerage of your choice. If you pick the right stocks, you can stand to make a decent amount of money often taxed at the relatively low long-term capital gains rate, and you won't have to pay management fees to an investment fund manager. On the other hand, you'll have to keep an eye on your investments yourself, and you also won't have the safeguards of investing in certain less risky investments, like insured bank products and government bonds.

How a Stock Account Works

Individual stocks by definition represent a partial stake of ownership in a company. They entitle you to participate to some extent in the company's governance, such as voting on candidates for the corporate board of directors. They also enable you to receive dividends, which are payments that companies can choose to make to shareholders as a way to share profits with their effective owners.

Of course, you can also make a profit by buying stock and later selling it for more than you paid for it. To do so, you generally work with a stock brokerage firm. Nowadays, most enable you to search for stocks online by name or using a ticker symbol, funding purchases with money transferred from your bank account.

Since so much of the market is now automated, commission fees charged when you buy and sell stocks have dropped, and some brokerages even offer free trades in certain or all circumstances. Remember to think about the fees involved when you plan to buy or sell stocks, since they can eat into your profits or add to your losses.

Since commissions are often flat regardless of how many shares you purchase or sell at once, it's often worth making one large trade rather than a few small trades, assuming your broker charges commission.

Individual Stocks Vs. Mutual Funds

If you decide to invest in the stock market, you'll likely want to spend at least some time getting acquainted with companies in which you might want to invest. This can involve online research, looking up news coverage, analyst reports and regulatory filings regarding particular companies.

Much of the information you'll need can be found through brokerage websites and through the investor relations pages run by the companies themselves. You can also obtain regulatory filings, such as quarterly and annual reports that are generally required by law, through the Securities and Exchange Commission.

Doing all of this research does take some time, however, and depending on your background and level of interest you may find it tedious or have concern that you can't compete with professional traders and fund managers.

An alternative to investing directly in the stock market is investing in a professionally managed mutual fund, where experts pool investor money to put into stocks, bonds and other investments, passing the returns on to investors after taking a fee. This fee structure is a deterrent to some investors, who'd prefer to skip paying fees and simply buy stocks for themselves, but others see it as a welcome trade-off for the mutual fund manager's expertise.

Individual Stocks Vs. ETF Investing

Another similar alternative is an index fund, which automatically tracks the performance of a stock market index such as the Dow Jones Industrial Average, the Standard & Poor's 500 or the tech-heavy Nasdaq Composite Index.

Many index funds are exchange-traded funds, which means you can buy them through most brokers similarly to buying stocks. Some financial institutions have index funds you can buy directly from them as well, similar to mutual funds. Because index funds don't rely on human expertise to the same extent as traditional mutual funds, they often have lower fees.

If you're interested in mutual funds or index funds, shop around for one with a fee structure you like from a company you trust.

The Stock Market and Risk

Investing in the stock market can be risky, since it's possible to lose some or even all of your money by investing in stocks with declining prices. If you invest in a company that goes bankrupt, you can even see your stocks become effectively worthless.

Naturally, some stocks are more risky than others, and you're generally more likely to lose money investing in a new and unproven company than in a blue chip industrial firm that's been around for decades. Investing in risky companies can also bring outsized returns, however.

Alternatives to Stock Market Investing

Alternatives to investing in the stock market include putting money into less risky investments, such as insured products available from banks. Savings accounts, money market accounts and certificates of deposit available at banks pay a steady rate of interest and are generally insured up to $250,000 per customer per bank by the Federal Deposit Insurance Corporation.

Accounts at credit unions are similarly insured by the National Credit Union Administration, and some states offer additional insurance for in-state bank deposits. The downside is that the major stock market indexes often have better returns than bank interest, and individual stocks have performed better still.

Bonds, which are securities that pay steady rates of interest, are also often seen as a low-risk alternative to the stock market. Bonds are available from government agencies, often with a tax advantage, and from corporations looking to borrow money.

Check the credit ratings and other information about bonds and the organizations issuing them to properly assess your risk. Bonds generally return a higher rate of interest than bank products with more risk, since they're not insured by the FDIC, but they're also usually less risky (and potentially less lucrative) than stocks.

Avoiding Scammy Stocks

Many investors will make a bad bet on the stock market now and then, but some will also be taken in by outright scams. These can take the form of advertisements and online message board posts touting get-rich-quick opportunities by investing in relatively unknown companies. Sometimes those sharing the information are secretly already invested in the companies themselves.

These scams are often referred to as pump-and-dump schemes, since the fraudsters will pump up the value of the stocks, then sell their own holdings, leaving other investors holding the bag. Try to avoid scams by taking stock tips you receive from unknown sources with a grain of salt and independently researching any investment opportunities you're presented with.

Investment scams aren't limited to stocks: There have also been fraudulent schemes associated with real estate in the past, and in recent years they've also migrated to new forms of investment like digital currencies.

Stocks and Taxes

One big advantage of investing in stocks and other securities, as well as certain investments like real estate, is that if you hold on to them for a year or more, you can pay tax on your proceeds at the long-term capital gains rate. This is 15 percent for most taxpayers, while some pay 20 percent or zero percent depending on their overall income. Some dividends, known as qualified dividends, are also taxed at this rate.

By contrast, money you earn from work, from nonqualified dividends and from interest is taxed at your ordinary income rate, which is usually higher. You can also claim losses on investments as capital losses, which can be used to offset capital gains or, to a limited extent, ordinary income.