Ready to make your money work for you? Before you jump in and start investing, take the time to learn about brokerage accounts first. After all, in most cases, a brokerage account is the best way to actively manage your investments.
To help you make an informed decision and open a brokerage account, we’ve compiled a comprehensive guide covering everything from fees to plan for your investments. So, take a few moments to equip yourself with all the answers to your burning investment questions, and you’ll be on your way to financial freedom!
How does a brokerage account work?
A brokerage account allows you to purchase and sell stocks and funds through a digital platform. You can generally deposit funds with cash or check and pay a pre-defined commission to your broker.
The fee you pay fluctuates according to the service you get and the level of automation provided by your chosen platform. Unlike a savings account where you gain a consistent interest rate on your deposits, a brokerage account earns (or sustains losses) depending on the performance of your chosen investments.
Although there is more risk involved, you are likely to reap higher profits than a low-interest savings account. However, if you have a strong appetite for risk, particularly if you are aiming for long-term investment, then considering a brokerage account as part of your savings portfolio might be viable.
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Types of Brokerage Accounts
When it comes to investing, there are a variety of brokerage accounts available to select from, each tailored to suit your individual investment objectives and risk appetite. Some common types of brokerage accounts include:
- Individual brokerage account: An individual brokerage account is a standard taxable account that is held in the name of a single investor, allowing them to purchase and sell securities such as stocks, bonds, mutual funds, and ETFs.
- Joint brokerage account: For those who wish to invest together, a joint brokerage account is an option, held in the names of two or more individuals, such as married couples or business partners.
- Retirement account: Retirement accounts are specifically tailored to helping investors save for retirement, offering certain tax advantages that can help their savings grow in the long term, including traditional IRAs, Roth IRAs, SEP IRAs, and 401(k)s.
- Trust account: Trust accounts are also available, set up to hold assets for the benefit of a third party, like a minor or estate beneficiary. These can be revocable or irrevocable trusts.
- Business brokerage account: Business brokerage accounts are set up to buy and sell securities on behalf of a business, such as a small business or startup looking to invest their cash reserves or raise capital.
- Custodial account: Custodial accounts are designed for the benefit of minors, often set up by a parent or guardian to save for a child’s education or other expenses, such as a 529 savings plan.
What can you invest in with a brokerage account?
There are actually a wide variety of options available. You may want to pick one type to start with, or you could choose several to diversify your portfolio. Perhaps the most familiar type of investment is a common stock, in which you essentially purchase shares of a specific company.
If you work for a large public company, you might receive shares as part of your compensation package. Or you can choose from any of the companies listed in the stock market, ranging from behemoths like Facebook to successful small niche companies. On top of common stocks, you can also add the following to your brokerage account:
- Preferred stocks
- Corporate or sovereign bonds
- Real estate investment trusts (REITs)
- Stock options
- Certificates of deposit (CDs)
- Money market accounts (MMAs)
- Exchange-traded funds (ETFs)
- Mutual funds
- Master limited partnerships (MLPs)
What should you consider when picking an online broker?
When opening an online brokerage account, the first thing to consider is whether you want a full-service or discount broker. Full-service brokerage accounts invariably comes with higher fees. But the upside is that you get a financial advisor who is dedicated to your investment account. You can discuss your financial situation and future monetary goals with your financial advisor and build an ongoing relationship.
With a managed brokerage account, financial advisors perform trades for you based on your financial goals and risk appetite. If you have questions or concerns, you can directly communicate with your broker by phone, email, or even an in-person meeting. You’re likely to pay commissions that are higher than those of a discount broker, but you have access to a seasoned professional at all times.
Discount Brokerage Firms
Discount brokerage firms, on the other hand, typically operate solely online. You execute all of your own trades in a truly do-it-yourself fashion. The advantage is that you can save lots of money. The disadvantage is that you have to rely solely on your own market research to develop your portfolio, and can cost yourself money by making mistakes out of sheer inexperience.
Still, if you want to be hands-on with your investments, online discount brokers make the stock market accessible — and affordable — in a way it has never been before. Here are a few other things to think about when choosing your brokerage firm.
There are typically two types of costs associated with an online brokerage account. The first is a commission fee, which can range anywhere between $5 and $10 for each trade you make. These fees usually apply to stocks and options, and sometimes ETFs, plus transaction fees for mutual funds.
However, some online brokerage accounts offer fee-free trades for ETFs and mutual funds. If either of those is a large part of your investment strategy, you may benefit from choosing a brokerage that doesn’t charge any fees for those.
Brokerage Account Fees
The second cost you’ll come across is various potential account fees. These can include an annual fee for maintaining your brokerage account, inactivity fees, and research and data fees for information provided by your broker.
Withdrawal & Transfer Fees
You may also incur fees for withdrawing or transferring your funds. Think about how often you plan to trade and what resources you want access to when assessing the value of these fees at different companies. If your annual fee is high but you’ll save money on lower trading fees, it might be worth it.
Similarly, if you don’t intend to trade very frequently, you might want to find a brokerage firm with low or no inactivity fees. Be sure to do a full review of all costs involved to make sure you get the best value across the board for your specific needs. Otherwise, your trades could end up costing you money over time, rather than earning you money.
Another factor to consider when choosing a brokerage account is how much money you initially plan to invest. Some online brokerages have a minimum amount just to get started, often requiring at least a few thousand dollars. Others don’t have any minimum requirements. In either case, you may notice varying fees depending on how much you invest.
For example, you may receive a discount by meeting a certain deposit threshold. In those cases, it also means you’ll end up paying more if you have a lower account balance. Carefully consider how much you intend to invest and where you receive the best perks for that amount.
In addition to research and data made available online (and often resulting in fees), consider what type of personal service you receive. Would you like an annual check-in with a real financial advisor? Do you prefer 24/7 email or chat support? Or do you need something more hands-on?
Just as the level of service varies between full-service brokers and discount brokers, you’ll see a difference even among different online brokers. Pay attention to your needs, and don’t be afraid to change your brokerage account further down the road if you feel you need more or less attention.
Cash Account vs. Margin Account
Yet another breakdown in types of brokerage accounts is a cash account versus a margin account. So, what’s the difference? A cash account is extremely straightforward: you simply trade with the exact amount of funds currently available in your account. This can be somewhat restrictive for a couple of different reasons.
First, cash used to purchase new stocks must be settled in your brokerage account, so if a previous transaction is still pending, you can’t use that money for a new trade. Second, you can’t make any withdrawals from a cash account until the money is fully settled.
Trading on Margin
A margin account essentially allows you to borrow money from your brokerage firm to cover short-term capital needs. The advantage is that it gives you a bit more flexibility in making time-sensitive trades.
One of the disadvantages is that you’ll have to pay a margin rate, which serves as interest on the short-term loan. Additionally, you may need to place a higher account minimum to compensate for the risk of the broker potentially losing money.
You can potentially qualify for a lower margin rate by permitting rehypothecation, which allows brokerage firms to reuse your collateral for their own purposes. Clearly, this brings additional risk to your portfolio.
If you’re a beginning investor, it’s probably wise to stick to straightforward cash trading. As you become more comfortable and active with the trading process, you can begin exploring the intricacies of margin trading with your broker.
How to Open a Brokerage Account
Opening a brokerage account isn’t terribly difficult and just requires a few pieces of personal information and, of course, money. When you’re ready to get started, gather basic materials such as your Social Security number or tax ID number, driver’s license, date of birth, and contact information.
You’ll also need employment and income information, including your employer, annual income (usually submitted using a W9 form), and your net worth. Assuming this information is easy for you to pull together, the process is both quick and easy, especially if you opt to open a brokerage account online.
You’ll also need cash to open a brokerage account. You cannot use a credit card to deposit funds. Instead, you’ll likely need to perform an electronic funds transfer from your bank account.
Keep a paper check on hand to facilitate the transfer. This process can take anywhere between a few days and a week so that the money can be verified. Once the funds hit your brokerage account, you can get started trading!
Should you use a brokerage account for retirement funds?
This is a very personal question which depends upon your retirement savings goals. First, it’s critical to take advantage of any employer-sponsored retirement accounts like a 401(k), especially if you receive a company match for your contributions. Then, consider contributing to a tax-advantaged retirement account like a Roth IRA.
There are limits on how much you can contribute each year, but you do both to enjoy different tax advantages. For example, a traditional IRA is not taxed until you begin withdrawing, making your annual contributions tax-deductible. Roth IRA contributions, on the other hand, are taxed when you make them.
The upside is that you don’t pay taxes when you start to withdraw, potentially saving you money during your retirement. If you’ve maxed out an appropriate amount of these account types, you might consider supplementing your retirement savings with a brokerage account.
Before you do, consider a few things. First, the earnings you make on selling investments are taxable, usually as capital gains tax. You’ll also want to review the amount of risk in your portfolio as you approach retirement age. Remember to review your holdings regularly, especially if you’re not a frequent trader.
With so many options available for brokerage accounts today, investing is more accessible — and affordable — than ever before. If you’re just beginning to get your feet wet, start by investing just a small amount of money to help you learn through rookie mistakes. Then you can grow into more sophisticated trading methods as you learn the full potential of your brokerage account.
Alternatively, you can switch to a more service-oriented account to take the day-to-day trading out of your hands. The options are quite limitless when it comes to managing a brokerage account.
Brokerage Account FAQs
Are brokerage accounts insured?
The Securities Investor Protection Corporation (SIPC) offers insurance for cash and securities held in a brokerage account should the brokerage fail, though this coverage only extends to the custodial function of the brokerage. Unfortunately, it does not extend to losses resulting from inadequate investment decisions or drops in the value of investments.
In addition, SIPC guarantees up to $500,000 per customer, with a $250,000 cap on cash. However, keep in mind that SIPC insurance does not shield against market losses or other dangers associated with investing.
Which brokerage account is the most suitable for beginners?
When selecting a brokerage account as a novice investor, there are a host of factors to consider, including the kind of investment products you have your eye on, fees and commissions, user-friendliness, and customer service. Here are some of the options you may want to think about:
- Robinhood: For those wishing to begin investing without incurring too many costs, Robinhood may be a good choice; it offers commission-free trading for numerous popular stocks and ETFs. However, it should be noted that Robinhood does not provide the same features as more traditional brokerage firms, such as access to research and investment advice.
- E*TRADE: E*TRADE is a much-revered brokerage firm that provides a vast selection of investment products, including stocks, ETFs, mutual funds, and options. The platform also provides access to educational materials and investment guidance, as well as a navigable platform with a wide range of tools and resources for rookies. That being said, E*TRADE does impose commissions on some trades and, as such, may not be suitable for those looking to make numerous trades.
- Charles Schwab: Charles Schwab is yet another highly regarded brokerage firm that offers various investment products and a user-friendly platform, and it boasts a plethora of resources and tools for novice investors, such as educational materials and investment guidance. Although it does charge commissions for certain trades, Charles Schwab does offer commission-free trading for certain ETFs.
At the end of the day, the best brokerage account for a beginner depends on their individual needs and objectives. Hence, it is advisable to shop around and compare the fees, commissions, and features of different brokerage firms before choosing.
How old do you have to be to open a brokerage account?
In the United States, you must be at least 18 to open a brokerage account in your own name. However, some brokerage firms may require a Social Security number or tax identification number to proceed.
If this applies to you, and you are under 18, it may still be possible to open an account with the help of a parent or guardian. A few brokerage firms offer custodial accounts, which are held in the name of minors, but managed by adults.
How much do you need to open a brokerage account?
The amount of capital required to start a brokerage account differs depending on the broker and type of account. Some brokers may require a minimum of $500 or $1,000 to open a regular account, while others may not have any minimum balance requirement. It all depends on the institution and the account you select.
What is a taxable brokerage account?
A taxable brokerage account is a type of investment account funded with after-tax dollars, meaning the money you put in has already been taxed at your marginal tax rate. Capital gains tax is typically assessed on the profits you make when you sell an asset for more than you paid for it, and is based on how long you hold the asset.
If held for a year or less, short-term capital gains are taxed at your ordinary income tax rate; if held for more than a year, the profits are considered long-term capital gains and are taxed at a lower rate.
Additionally, any dividends or interest earned from your investments in the account are considered taxable income, and must be reported and taxed accordingly. To ensure you make the most informed decisions and minimize your tax liability, consult a financial professional or tax advisor before investing.