Basics of Stock Investing

Here is a basic guide to the process of setting up a brokerage account and buying and selling shares.

A brokerage account is much like a checking account, except it can hold shares of stock or other investments in addition to cash.

Open an account

You open a brokerage account the same way you open a checking or savings account, filling out some forms and making an initial deposit. Nowadays this is usually done online, but you can also visit a local office of the broker you want to use. You’ll need to provide your Social Security number and, if you’re married, specify whether this account will be in your name alone or a joint account with your spouse. Brokers usually require a minimum deposit, which is smaller at some brokers than at others. There is no upper limit to the amount you can deposit in a regular brokerage account.

Disposition method. You may be asked to specify a disposition method that will determine the order of sale when you’ve bought the same stock at different times and different prices. Will you automatically sell the oldest shares first (a method known as first-in, first-out, or FIFO)? Or manually select the shares you’re selling (a method called identification)? FIFO is easy, but identification gives you greater control over the tax consequences when you sell part of your holdings. See Multiple Lots of Shares.

Buying stock

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Once you have an account open and money on deposit you’re ready to buy some stock. Here again online transactions have become most common, although some brokers accept orders by telephone, often for an extra charge. You’ll need to know the stock symbol (easy to find on many websites) and the number of shares you want to purchase.

When you place your order, you can specify the maximum purchase price you’re willing to pay. This is called a limit order. Otherwise you simply accept whatever price is currently available in the market: a market order. An order placed while the stock market is open is usually executed almost instantly unless it’s a limit order at a price sellers are not currently accepting.

The date your broker executes the order is the trade date. The actual transfer of shares and cash occurs a few days later on the settlement date. For ordinary purchases and sales, the tax law uses the trade date to determine when you bought or sold shares of stock. See Trade Date and Settlement Date.

Records. Brokers are required to maintain records that can be used to report the tax consequences of selling shares. For various reasons, however, you may have to do your own calculations of gain or loss, so you should make sure you have a permanent record of the following information:

  • The trade date of the purchase
  • A description of what you bought (25 shares of XYZ)
  • The purchase price of the stock
  • The commission, if any

The commission isn’t considered an expense you can claim as a separate deduction. It’s added to the purchase price to determine your basis, which is used in calculating gain or loss when you sell the shares.

Selling stock

Selling works the same as buying. Through the broker’s website, or perhaps on the phone, you tell the broker what you want to sell. If the market is open, the sale will normally go through immediately. The cash balance in your account will increase by the amount of sale proceeds reduced by the commission.

The broker won’t send the money to you unless you request it. You report the gain or loss in the year the transaction occurs, though, even if you leave the money in the brokerage account.

Records. Time to update your records. The sale record will be very similar to the purchase record, with added items:

  • The trade date of the sale
  • A description of what you sold (25 shares of XYZ)
  • The proceeds (price you received, net of any commission you paid)
  • Your cost or other basis
  • If applicable, the amount of loss disallowed under the wash sale rule
  • The holding period of gain or loss (short-term or long-term)

The trade date of the sale is used for two purposes. First, it determines what year you report the gain or loss. For example, if your trade date is December 31, you’ll report your gain or loss on your income tax return for that year, even though the settlement date doesn’t occur until the following year. As explained below, the trade date of the sale is also used to determine your holding period.

Amount of gain or loss. Your sale proceeds are equal to the sale price minus the commission. You determine the gain or loss by subtracting your basis from the sale proceeds. Your basis is normally the amount paid for the shares, increased by any commission or other costs of purchase. There are a number of rules that may affect stock basis in various situations.

Holding period. Besides the amount of gain or loss, you need to know the holding period, which is short-term or long-term. Your holding period is long-term if you held the shares more than a year, as measured by the trade dates of your purchase and sale.

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