Two things to remember, especially when you’re first starting out in investing, are commissions and taxes.
Commissions:
After I made my first few investments I had a small amount of cash left in my account. So I picked a cheap ($10) stock and bought a few shares. The stock really took off and after a year it had gone up 20%. That’s a pretty nice gain, but the value of my investment was so small that the commissions ate up a large chunk of that gain.
Lesson Learned: From now on, the absolute minimum that I invest in a stock is $500. Why? Scottrade, my broker, charges $7 for market and limit orders, which is about as cheap as they come. So to buy some stock and eventually sell it costs me a total of $14. I picked $500 as my minimum investment because $14/$500 is less than 3%. So the first 3% of my gains go to commissions and the rest is mine to keep (Except for Taxes, See Below) If my investment can’t get me at least 3%, then it’s probably not a good investment to begin with.
Taxes:
You have to pay income taxes on all of the gain you make on a stock. You pay it in the year in which you sold the stock. If you held the stock for less than a year, then it’s a short-term capital gain and is taxed like regular income. So the rate is between something like 22%-35% depending on your income level. If you held the stock for more than a year, then it’s a long-term capital gain and is taxed at 15%. The year threshold is obviously also used for long-term/short-term losses.
Taken together, remembering taxes and commissions can significantly change your rate of return if you only have a small amount of money invested. If you make 15% on a $500 short-term investment, then you really only make 8%, because your gain is reduced by two $7 commissions, and $21 for taxes (assuming 28% tax bracket) reducing your $75 gain to $40. If you want a true 15% on your $500 you would need to start with a gain of 25%.
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