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Stock Purchases and Cost Basis
In recent years, many investors have opened online accounts with
brokerage firms, and they buy and sell stocks using a computer.
However, these buy and sell orders are still placed by the brokerage
company, and a fee is charged to the investor for this service. The
fee is called a commission. These online transactions are typically
the least expensive way to buy or sell stocks, since a live person is not
required to deal with the customer directly in order for the trade to be
processed.
Many investors still call their broker via telephone to place a buy or
sell order. Typically, these transactions cost more in commissions,
especially if the broker is providing advice on which stocks to buy or sell.
The cost of dealing with a broker in this manner may be many times the
amount of an online trade.
Once the investor has either logged on to his or her brokerage account or
called his or her broker, the investor receives information about the
current price of a stock. If the investor considers that the price
being quoted for a stock meets his or her own investment goals, then a buy
or sell order might be given at that time.
Since the price of a stock often fluctuates, the price quote the investor
is given by his or her broker, or the price quote they saw online may not be
the same as the price at which the actual transaction occurs. For
instance, the shares of a particular company may be shown at $22.50, but by
the time the customer hits the place-order button on his computer, perhaps
the price has ticked up to $23. Perhaps it has dropped to $22.25.
This reflects the auction-like atmosphere of the stock trading floor.
Sometimes, though, these price bumps represent manipulations by shrewd stock
players who make money by buying and selling a particular stock many times
during the day.
EXAMPLE:
An investor calls his broker and places an order to buy 100 shares of a
company. The price quoted is $40 per share. the commission
charged by this particular broker for this kind of transaction is $50.
Bought 100 shares at $40
per share= $4,000
Commission Charged= $50
Total cost of this block
of shares was= $4,050
The cost basis per share is found by dividing $4,050 (total cost) by 100
(number of shares bought). The cost basis per share on this
transaction was $40.50. Knowing the cost basis per share can be
important when large blocks of stock are bought and then sold in smaller
blocks over a period of time.
You can see from this example that the price of the stock would need to
go up beyond $40.50 for the investor to make money by selling this stock.
Considering that there will be commission charged when they go to sell the
stock, the price of this stock would need to be over $41 per share for the
investor to make any money, if he pays the same commission fee on the sale
of the stock.
Activity
Answer the following
questions concerning total cost and cost basis per share.
Group Activity If you are buying a small
number of shares of a relatively inexpensive stock (for example, 20 shares
of a $10 stock), how does the commission affect the cost per share
differently than buying a large number of shares of a more expensive
company?
Why would the cost of commissions be of less worry to a person who only
buys or sells stock a few times a year and selects only the stock of
companies they plan to keep for a long time?
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