What Is a Brokerage Account and How Does It Work?
Before you begin to build your fortune by investing in stocks, you will have to open a brokerage account. A brokerage account is simply an investment account where you can deposit your money and then use it to buy or sell stocks, bonds, mutual funds or other types of assets. So, even if you’re a complete do-it-yourself trader working with an online-only broker, you’ll still need to open a brokerage account.
Here’s everything you need to know about how a brokerage account works.
How Does a Brokerage Account Work?
A brokerage account is a financial account designed to allow investors to buy and sell investments. Think of it as a bank account that you can open at a brokerage. There are no limits as to how much you can deposit in a brokerage account, although some accounts limit their insurance to the standard $500,000 provided by the SIPC. You can open as many different types of brokerage accounts as you would like, with any number of different brokers. You aren’t restricted to keeping all your money at a single firm.
Types of Brokerage Accounts
You can choose from several types of brokerage accounts. The best brokerage account for you will depend on your needs and investment goals.
Full-Service Brokerage Account
A full-service brokerage provides clients with a variety of services, including investment advice, retirement planning help and other wealth management services. This type of brokerage account might be the best trading platform for someone who doesn’t have the time or desire to stay up to date on financial news and regulations and who wants more services outside of basic trading. Commissions tend to be higher at full-service brokerage firms than at discount brokers, however.
Examples of companies that offer full-service brokerage accounts include:
- Morgan Stanley
- Wells Fargo Advisors
Discount Brokerage Account
Discount brokerages offer stock trading and other investment trading per the client’s wishes; they do not provide advice or wealth management services. Because discount brokers do not offer the same suite of services as full-service brokers, their commissions are much lower.
Discount brokerage accounts are a good option for people:
- With enough knowledge of the stock market to not need advising
- Who trade often and will benefit from the lower commissions per trade
- Who don’t have the means to pay for a full-service brokerage
Examples of companies that offer discount brokerage accounts include:
- Ally Invest
- Fidelity Investments
- TD Ameritrade
Online Brokerage Account
Online brokerage accounts are discount brokerage accounts that allow clients to buy and sell investments directly online. Because overhead costs are low for online brokerages, commissions are usually very low, as well. These types can be good brokerage accounts for beginners.
Nowadays, you can choose from numerous online brokerages, including E-Trade, TD Ameritrade, Charles Schwab and Fidelity Investments. When making an online brokerage account comparison, take into account the commission charged, whether or not commission-free trading is available, the minimum account balance and any additional services offered by the broker.
Managed Brokerage Account
Managed brokerage accounts incorporate professional portfolio management for a fee, rather than individual trading commissions. Traditionally, human investment managers allocated client funds according to chosen risk-and-reward parameters. But the newest frontier has incorporated computer-based algorithms to allocate customer funds — a process known as robo-advising.
Retirement Brokerage Account
A retirement brokerage account is a tax-advantaged account that is designed for long-term investment. Retirement accounts, such as individual retirement accounts, allow you to defer taxes on your investment until you withdraw them after age 59.5. Generally, you can invest in the same types of investments — such as stocks, bonds and mutual funds — in an IRA as you can in a regular investment account.
When choosing your brokerage account, you will also need to decide between a cash account and a margin account. With a cash account, you can only purchase securities with the money you have in your brokerage account, or “in cash.”
With a margin account, you can borrow money from the broker to invest in securities, but you will have to pay interest on the money borrowed. If the value of your shares declines too much, the broker can sell your shares to pay back the loan.
Types of Investments a Brokerage Account Can Hold
Having a brokerage account enables you to buy and sell numerous investment products, all of which come with their own risks and benefits. Here are some of the most common investment products:
- Common stocks: A common stock allows the shareholder to vote at shareholder meetings and to collect dividends.
- Preferred stocks: Preferred stockholders receive dividends before common stockholders, and they get priority over common stockholders if the company goes bankrupt and is liquidated. They don’t typically have voting rights, however.
- Bonds: A bond is a loan with defined terms for the borrower to pay back the lender. When choosing a bond, the lender should take into consideration the yield, maturity date and rating.
- REITs: A real estate investment trust allows an individual to invest in a large-scale property, such as a shopping mall or apartment building. REITs are generally considered safe investments with high returns.
- Mutual funds: With mutual funds, a pool of money is collected from many investors that is then used to invest in other securities, such as stocks, bonds and short-term debt.
- ETFs: Like mutual funds, exchange-traded funds are a collection of funds from a pool of investors that are used to purchase other securities. Unlike mutual funds, however, ETFs are traded on an exchange.
- MMAs: Money market accounts are similar to savings accounts. They typically offer higher interest rates than traditional savings accounts, but they usually require a higher minimum balance and limit the number of withdrawals the account holder can make in a given period of time.
- CDs: Certificates of deposit are considered low-risk investments. With a CD, you deposit a fixed amount of money for a fixed period of time, during which your investment accrues interest at a rate typically higher than what you would get with a traditional savings account.
- Options: An option is a contract that gives the owner the right to buy or sell a certain asset at a set price on or before a specified date. Options trading can involve a range of financial products, including stocks and foreign currencies.
- Cryptocurrency: Not all brokerage accounts allow investments in cryptocurrency, such as Bitcoin, but the numbers are increasing, particularly among online brokers.
How To Choose a Brokerage Account
Since there are countless different types of brokerage accounts, you’ll likely have no trouble finding a large number that will suit your needs. Before you choose, take a self-test to determine what type of investor you are.
Questions To Consider
Are you completely self-sufficient and cost-conscious? Then an online broker with no commissions might be your best option.
Are you new to investing and not likely to make very many trades per year? Then a full-service broker might be a better option, as you can still keep your overall costs low while receiving investment guidance.
If you’re opening an account solely to trade cryptocurrency, you’ll have to search for a firm that provides that capability. Alternatively, you can compare some of the best crypto exchanges to find a platform that suits your needs.
Opening a Brokerage Account
Opening a brokerage account is a fairly easy process; most financial institutions will allow you to fill out the application online. You will typically need to provide the following personal information to open your brokerage account:
- Social Security number
- Date of birth
- Valid mailing and email addresses
- Employment information
- General financial information, such as a checking account to fund your brokerage investment account
Once you open your account, you can begin trading.
Do I Need a Brokerage Account?
A brokerage account is a necessary part of investing. Even if you buy shares of stock directly from a company or use an investment app to trade, your first step will be to open an account. At the very least, firms need an address to send you important financial statements and your Social Security number so they can report your income to the IRS.
However, a brokerage account is much more than just a holding place for funds. Nowadays, brokerage accounts have evolved to the point that they provide numerous features and benefits, from performance tracking to market research and auto-rebalancing. Choosing the right one can greatly enhance your overall investment experience.
John Csiszar contributed to the reporting for this article.
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