If you are a new investor looking to invest in shares, you could wonder what is a good number of shares to buy? You may have already chosen a company to invest or could be actively looking for one. Either way, in this post you will get answers to your question.
Two important objectives you should focus to decide on number of shares are
- Reducing broker commissions
- Reducing portfolio risk
Let us see both the factors in detail.
1. How Broker Commission Helps You Decide How Much Stock To Buy
As a first step, you should learn your broker’s commission before trying to decide on number of stocks to buy. This is very important especially if you are just beginning to invest.
Are you very new to investing and haven’t yet chosen your broker yet? And do you wonder how to decide who is your best fit? In that case, commission is an important metric to compare brokers. On the contrary, you may have already chosen your broker. Either way, you should look at their charges before deciding on number of shares to buy.
But, how will you know a broker’s commission?
To help you, several popular finance websites list popular brokers and their commissions. Consider Nasdaq.com for example. Below is a screen shot of a list of stock brokers and their commissions.
In the above screen shot, you will find charges and details of top brokers. For example, consider OptionsHouse. This company will cost you 4.95$ per trade (as on Feb 5, 2016.) As you can observe, the brokerage is not based on the number of shares you will buy but is based on the number of transactions. You may buy 1 share or 10 share or 10000 shares. In every case, your commission is flat 4.95$.
Assume that share price of a company is 10$. Assume you are planning to buy 100 shares in total. So you are going to invest require 1000$. Now there can be two scenarios. You can either buy all 100 shares at once, or buy 10 shares each month for 10 months.
Case I: Assume you buy 100 shares at once
If you buy 100 shares at once, you will just be paying 4.95$ in commission, which is 0.005% of your investment.
Case II: Assume you buy 10 shares per month for 10 months
Every time you buy 10 shares, you will be paying 4.95$ in commission. Since you are going to pay 10 times in 10 months, your total commission will become 4.95*10 = 49.5$.
Your commission jumped from 4.95$ to 49.5$ for the simple reason that you didn’t buy enough number of shares in one transaction. So you should be careful if you buy relatively small number of shares in one transaction.
Regarding brokerages, you will also be paying commissions not only when you buy but also when you sell shares. This could add to the number of transactions and could increase your overall commission amount.
2. How Your Decision On Number Of Shares Will Help You To Reduce Portfolio Risk
Broker commissions help you decide a certain minimum number of shares to buy. But what factor will help you decide on a maximum limit? Here it is. Your risk tolerance.
You would have heard a lot about benefits of diversification. In simple terms, analysts use the term portfolio diversification to warn you not to put all eggs in one basket.
There have been theories like Modern Portfolio Theory to help you decide on diversification. The basic principles of diversification include
- You should invest in many companies at once. Some analysts recommend at least 5
- You should choose companies belonging to different sectors.
- You should do your homework and allocate assets properly. Analysts recommend that you should always invest a reasonable percentage of money in other asset classes like bonds, index funds, metals, etc.
But how diversification helps you decide on number of shares?
You should generally invest only as much your overall strategy is maintained. For example, if you are in your 50s and do not want to risk too much in stocks. You could very well decide that your 30% of investment will be in CDs, treasury bonds, etc. You may decide that you could invest another 20% in slightly riskier mutual funds. You may decide to invest your remaining 50% in shares. But again you want to invest in 5 companies in different sectors. A pictorial representation of this strategy is shown below.
Now, assume you have decided to invest a total of 10,000$. According to the above strategy, your investment pattern will be as shown below.
CDs – 3000$
Mutual Funds – 2000$
Company Shares – 5000$
According to the example strategy, you will be investing in 5 different companies using 5000$. For every company, you can roughly spend around 1000$. Hence, you should buy only that many number of shares you can for 1000$.
Assume share prices of five companies to be 20$,100$,50$,10$ and 40$ respectively. Then, number of shares you will be buying are:
What is your takeaway
The number of shares you buy should not be too low because you will paying higher percentage of commission. Also, the number of shares should not be too high to break your diversification strategy.