Whether you are completely self-sufficient or you are new to investing, before you dive in you’ll need a brokerage account. You may want help from an online broker with no commissions or opt for a full-service brokerage to receive investment guidance. Either way, it’s important to understand your choices. Here’s all you’ll need to know.
How Does a Brokerage Account Work?
A brokerage account is simply a holding place for your investable money. You can use it to buy and sell securities, transfer money in or out, or simply hold the money in the account. Brokers facilitate trades in your account, either through an online interface or via more traditional methods like a phone call or an in-person visit. Nearly all trades settle, or become finalized, on the following business day, according to industry regulator FINRA.
Types of Brokerage Accounts
There are several different types of brokerage accounts, and it’s important to open the right one(s) to suit your needs.
Individual Brokerage Accounts
As the name suggests, individual brokerage accounts are for individual account holders. They must be in a single name only.
Joint Brokerage Accounts
Joint brokerage accounts are listed in two or more names, and assets are shared among the account owners. This can offer additional flexibility, as any owner can enter trades or control the assets in the account, but that can also be a drawback, depending on the situation.
Retirement Accounts (IRAs, Roth IRAs)
A retirement brokerage account is a tax-advantaged account that is designed for long-term investment. Retirement accounts allow you to grow your money on a tax-deferred basis – or tax-free, in the case of Roth accounts – until you withdraw it. 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.
Custodial Accounts
Custodial accounts are investment accounts for minors. They differ from regular brokerage accounts in that they must be owned by an adult for the benefit of the minor. Upon reaching the age of 18, the custodial account becomes the legal possession of the former minor.
Key Features of a Brokerage Account
A brokerage account is a financial account that allows investors to buy and sell investments. Think of it as a bank account you can open at a brokerage. There are no limits as to how much you can deposit, 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. Here are the key features you’ll want to understand.
Access to Investment Options
In most brokerage accounts, you can invest in nearly any security you like, from stocks and bonds to ETFs, mutual funds, and so on.
This broad range of investment options allows you to diversify your portfolio in a single brokerage account.
Margin Accounts
A margin account allows you to borrow money from your brokerage firm to buy additional securities, using your account value as collateral. For example, if you have a $50,000 account, you may be able to buy investments worth $80,000 or more by borrowing that $30,000-plus from your brokerage firm.
Borrowing from your brokerage firm means you’re taking out a loan, so you’ll be paying interest on it. If you earn 8% on your investments but have to pay your brokerage firm 9% in interest, for example, you’re still losing money. When you trade on margin, you are leveraging your account. While margin can amplify your gains, it also magnifies your losses.
Tax Implications
Traditional brokerage accounts are fully taxable, meaning you’ll pay tax on your capital gains, dividends, and ordinary income at their respective rates. Tax-advantaged accounts like IRAs and 401(k) plans, however, can shield you from paying taxes until you withdraw your money from the account.
Understanding Brokerage Account Fees
Commissions and Trading Fees
Before you open a brokerage account, be sure to understand how you’re going to pay for your trades. Historically, brokerage accounts charged a per-trade commission, but now most online brokers charge no commissions at all. Other brokers might charge a percentage of your assets as a management fee instead of charging commissions.
Account Maintenance Fees
Some brokerage accounts might charge miscellaneous fees that you’ll want to look out for. For example, some types of accounts, especially retirement accounts, may charge an annual account maintenance fee. Others might charge inactivity fees, if you don’t make a certain number of trades over a certain period of time.
Additional Costs
The investments you choose may carry their own hidden expenses that you might not even be aware of. For example, mutual funds and ETFs typically charge fees internally via expense ratios, which are automatically deducted from their value without being clearly visible. Other potential additional costs include margin loan interest if you borrow money from your brokerage firm to purchase investments.
Advantages of Having a Brokerage Account
- Access to a Wide Range of Investment Options. The primary reason to have a brokerage account is to be able to invest in stocks, bonds, ETFs, mutual funds and a variety of other securities.
- Control Over Your Investment. With a self-directed brokerage account, you get to choose which investments you buy and when. This differs from a managed account, in which you hand over control of your assets to a third party.
- Opportunity for Long-Term Wealth Building. A brokerage account can help you achieve a wide range of longer-term goals, such as saving to buy a home, investing for retirement, or building an education fund.
- Tax Flexibility. With your own brokerage account, you can take control of your tax situation. If you have outstanding gains, you can harvest losses to lower your tax liability. You can also pick and choose which capital gains to take, whether short-term or long-term.
Risks and Considerations of Using a Brokerage Account
- Market Risk. If you invest in the stock market, even via mutual funds or ETFs, you should expect some volatility. Although a brokerage account offers you the opportunity to invest in a wide variety of securities that can generate profits, you’ll have to be prepared for the ups and downs of your account value.
- Brokerage Risk. All legitimate brokerage firms carry SIPC insurance that helps protect your investments in case of institutional failure. However, you should still seek out reliable and regulated brokers that are well-funded and trustworthy.
- Tax Implications. If you trade often, you might generate short-term capital gains, which are taxed at your ordinary income tax rate instead of the more favorable long-term capital gains rate. If you’re an income investor, you’ll want to make sure any dividends you earn are qualified so that you can benefit from more favorable tax rates.
How To Choose the Right Brokerage Account for You
No single brokerage account is right for every investor. You’ll have to determine which account best matches your goals and investment profile. For example, some firms are a better match for short-term, frequent traders, while others are better for long-term retirement savers. Here are some other considerations you’ll want to take into account:
- Account maintenance fees
- Trading commissions
- Annual fees
- Margin loan rates
- Account minimums
- Access to investments
- Trading or investing tools
- Customer service
- Mobile app
- Educational resources
How to Open a Brokerage Account
Opening a brokerage account is an easy process that you can generally complete online. Here are the steps to take:
- Choose the right brokerage firm. Financial services is a competitive industry, meaning each firm will have its own unique strengths and weaknesses. Find the one that is the best fit for your needs, whether that is a low fee structure, access to a broad product line, in-branch services and so on.
- Provide required documents and personal information. You will typically need to provide your Social Security number, date of birth, valid mailing and email addresses, employment information, and general financial information, such as details about your checking account for funding purposes.
- Verify and fund your account. Once you verify that all information in your application is correct, you can link your funding source and make your initial deposit.
Is a Brokerage Account Right for You?
If you want to invest in anything from stocks and bonds to ETFs and more, you’ll need to open a brokerage account. But there are so many different types of accounts and firms that you’ll want to shop around to find the one that best serves your needs. Whether you’re looking for a simple online account with low fees or a full-service brokerage with professional management, you’ll find plenty of options to choose from. Choose the one that provides all the services you need and feels like the best fit.
Caitlyn Moorhead contributed to the reporting for this article.