A brokerage account is a platform that allows you to buy and sell financial securities in a safe and secure manner. You use brokerage accounts to invest in stocks, bonds, mutual funds and exchange-traded funds. Learn more about these types of accounts and how they can help you grow your wealth.
What Is a Brokerage Account?
Brokerage accounts are financial accounts that allow you to buy and sell a variety of securities such as stocks, bonds, options and fund-style vehicles containing various combinations of these assets. You can establish brokerage accounts on either a taxable or tax-advantaged basis.
Most brokerage accounts are set up as taxable accounts. This means that all transactions that take place within them are taxable in the year they are executed.
The Internal Revenue Service (IRS) sponsors tax-advantaged brokerage accounts. These types of accounts, such as 401(k) plans, are often used to help save for future expenses like retirement.
You can open a brokerage account through a major brokerage firm such as Charles Schwab, E-Trade or Fidelity Investments. Whichever firm you choose, it will essentially act as a middleman between you and your investments.
In addition to facilitating your trades, the firm will maintain pertinent records and safeguard your investments through behind-the-scenes custodial arrangements. Many brokerage firms also offer investment planning and advisory services to help guide you through the process of investing your money.
What Is the Point of a Brokerage Account?
Brokerage accounts allow you to gain access to investments that can help you grow your wealth and prepare for major phases of life, such as buying your first home, sending a child to college or retiring with enough money to live comfortably. With a brokerage account, you can buy and sell stocks, bonds, alternative investments and fund-style vehicles such as mutual funds and exchange-traded funds (ETFs).
There are numerous types of assets you might invest in with a brokerage account. However, the combination of assets you invest in should fit your investment objectives and your tolerance for risk. Generally, this means that you should hold a relatively large proportion of growth-oriented investments (like stocks) when your time horizon is long. If your time horizon is short, you should hold a relatively large proportion of fixed-income investments (like bonds).
Regardless of your investment situation, putting your money into a brokerage account offers a wide range of benefits.
- Your assets can generate passive income
- Investments can offer the potential for long-term growth and allow you to capitalize on compound interest
- You can implement investment strategies that provide a hedge against inflation
- Wise investment strategies can minimize capital gains taxes
- You gain access to tools like educational resources and innovative research
How Is a Brokerage Account Different From Other Accounts?
Depending on your level of investment experience, the concept of a brokerage account may be new to you. Let’s examine what makes brokerage accounts different from other common types of financial accounts such as checking and savings accounts.
|Taxable Brokerage Account||Tax-Advantaged Brokerage Account||Traditional Checking Account||Traditional Savings Account|
|Purpose||Investing for different time horizons.||Long-term investing to facilitate savings.||Facilitating routine spending.||Saving excess cash at low interest rates.|
|Typical Fee Structure||No setup fees or commission fees for online trades of stocks and ETFs. Investment planning and advisory fees vary.||No setup fees or commission fees for online trades of stocks and ETFs. Investment planning and advisory fees vary.||No fees are levied, except in unusual circumstances like spending with insufficient funds.||No fees are levied as long as a minimum balance is maintained.|
|Taxation||Interest and dividends received are taxable, as are capital gains on asset sales.||Potential for either upfront tax deductions on contributions coupled with tax-deferred growth, or tax-exempt growth on contributions.||No taxes are typically levied.||Interest is taxable.|
|Contribution Limits||None.||IRS sets annual limits and eligibility requirements.||None.||None.|
|Withdrawal Limits||None, but a minimum account balance may be required.||Subject to IRS guidelines.||None.||None, but a minimum account balance may be required.|
Another major difference between brokerage accounts and commercial bank accounts relates to deposit insurance. Most bank accounts are insured for up to $250,000 per accountholder by the Federal Deposit Insurance Corporation (FDIC).
In contrast, the Securities Investor Protection Corporation (SIPC) generally insures brokerage accounts at amounts up to $500,000 per accountholder. SIPC insurance does not protect you against investment losses; rather, it safeguards your assets if your brokerage firm ever goes bankrupt.
Types of Brokerage Accounts
As explained below, there are a few different types of brokerage accounts. Each type of account fulfills a specific need in the investment market.
Full-Service Brokerage Accounts
A full-service brokerage account is a good option if you’re an investor who will need the advice and expertise of a financial advisor. In exchange for a hefty fee, a full-service broker will design a customized investment plan for you and execute all downstream transactions. These transactions can be done on either a nondiscretionary or discretionary basis. Nondiscretionary transactions will not require your approval, but discretionary transactions will.
Discount Brokerage Accounts
A discount brokerage account is ideal if you want to manage your own investments, and there are online discount brokerages that let you do everything online. This type of account allows you to easily buy and sell investments at minimal cost, but it will have fewer features (and less help) than full-service brokerage accounts.
As the name suggests, these accounts do not charge commission fees for placing a stock trade. However, you may still experience charges on other types of services, like contract fees for options or advisory fees.
Custodial Brokerage Accounts
Traditionally, a parent or guardian sets a custodial brokerage account up for a minor. In the same vein as a custodial ROTH IRA, a custodial brokerage account allows the custodial parent to oversee account activity while allowing the minor to be exposed to real-world financial situations.
As part of the setup process for a brokerage account, you may be asked whether you want to establish a cash account or a margin account. A cash account is the standard option, and it means that all trades will be settled immediately with cash.
A margin account allows you to place trades using money borrowed from the brokerage firm. It’s relatively easy to establish a margin account, but your brokerage firm will have to evaluate your investment experience and your ability to pledge collateral before activating your account.
After activating the margin trading feature, you are free to trade with borrowed money as much as you like — but you’ll have to pay interest. You’ll also have to maintain an appropriate amount of collateral in the account. The collateral can take the form of cash or equity in the financial securities held in the account.
What if I Don’t Know Much About Investing?
When figuring out which type of brokerage account makes the most sense for you, there are some important things you should consider. We’ll touch on some of the biggest factors, or you can review our guide to investing for beginners if you need more information.
First, think about how much help you’ll need with managing your investments. Are you self-sufficient or will you require guidance and ongoing support?
Online discount brokerage accounts are good for do-it-yourself investors who have clear investment goals and a thorough understanding of their tolerance for risk. If you want some help creating and maintaining a portfolio, automated robo-advisor accounts can be a cost-effective solution, as they use sophisticated computer algorithms to help manage your investments. If you need hands-on human interaction and highly customized offerings, full-service brokerage firms will be your best bet.
Next, consider the types of assets you want to invest in. The best brokerage firms provide access to all potential assets, but less competitive firms will have limited offerings. Always try to go with firms that won’t restrain your opportunity set.
Also, pay attention to the account fee structure. Depending on the level of service required, some accounts will have fees that you just can’t avoid. Nevertheless, it’s best to avoid unnecessary and excessive fees as much as you can — they can have a serious drag on investment performance and eat away at your savings.
- Account setup fees are rare and usually indicate a potentially unscrupulous provider that you should avoid.
- Maintenance fees are also fairly unusual.
- Commissions on investment trades are common and can range from a few dollars to $100 or more per trade, depending on the type of asset being bought or sold. Fortunately, the most competitive brokers have eliminated this expense for online trades of stocks and ETFs.
- Investment management fees are another common charge. If you have an online discount brokerage account, you can easily avoid this expense, but if you want advisory services, you’ll have to pay for them. Technologically driven, automated solutions are relatively inexpensive. High-touch, human-to-human services will always be more expensive.
A final consideration relates to account minimum requirements. Some brokerage firms require a minimum initial deposit to open an account. This is most common with robo-advisor accounts and full-service accounts. Online discount brokers rarely impose account minimum requirements.
How To Open a Brokerage Account
If you work with a financial advisor, they can guide you through opening a brokerage account. If you don’t have a financial advisor, you can work directly with the brokerage firm. The process is generally very simple and can often be completed in less than 15 minutes.
Typically, you’ll fill out an online form and give them information about your employment, net worth and investment goals, along with identifying information such as your driver’s license number and social security number.
Then, you’ll link your brokerage account to your checking or savings account to facilitate the funding process. If you’d rather not link your brokerage account to your bank account, most brokerages will allow you to make deposits via wire transfer or check.
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- Corporate Finance Institute. (2021, October 22). Robo-Advisors. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/robo-advisors/
- Financial Industry Regulatory Authority Inc. (n.d.). Purchasing on Margin, Risks Involved with Trading in a Margin Account. Retrieved from https://www.finra.org/investors/learn-to-invest/advanced-investing/purchasing-margin
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