What Is a Brokerage Account and How Does It Work?
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. But either way, understanding your choices is imperative.
Read: 3 Things You Must Do When Your Savings Reach $50,000
What Is 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 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.
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 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.
Types of Brokerage Accounts
There are several types of brokerage accounts to choose from. The best brokerage account for you will depend on your needs, investment goals and how tax-free you want to be. Here are seven types of brokerage accounts to explore:
Full-service
Managed
Retirement
Discount
Online
Cash account
Margin account
1. Full-Service Brokerage Account
A full-service brokerage provides clients with a variety of services. These can include investment advice, retirement planning help and other wealth management services. This type of brokerage account might be best for someone who doesn’t have the time or desire to stay up to date on financial news and regulations. Or someone 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:
Merrill
Morgan Stanley
UBS
Wells Fargo Advisors
2. Managed Brokerage Account
Managed brokerage accounts offer professional portfolio management for a fee, rather than individual trading commissions. Traditionally, human investment managers are allocated client funds according to chosen risk-and-reward parameters. These brokerage accounts might also use robo-advisors, which use computer-based algorithms to allocate customer funds.
3. 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 avoid paying taxes on your investment. This would be until you withdraw your funds after the age of 59. 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.
4. 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 best for you if you meet any of these criteria:
You have enough knowledge of the stock market to not need advising.
You trade often and will benefit from the lower commissions per trade.
You 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
Robinhood
TD Ameritrade
5. Online Brokerage Account
Online brokerage accounts 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 and you can choose from numerous online brokerages such as:
E-Trade
TD Ameritrade
Charles Schwab
Fidelity Investments.
When comparing online brokerage accounts, consider if there are any commissions charged. You should also note the minimum account balance required and explore the additional services offered by the broker.
6. Cash 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.”
7. Margin Account
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. They also get priority 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 repay 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. This could be 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. It is then used to invest in other securities, such as stocks, bonds and short-term debt.
ETFs: Similar to 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 usually offer higher interest rates than traditional savings accounts, but require a higher minimum balance. They also 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 set period of time. During this time, you accrue 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, but the numbers are increasing, particularly among online brokers.
How To Open a Brokerage Account
Opening a brokerage account is an easy process as 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 like details about your checking account for funding purposes
Once you open your account, you can begin trading.
Final Take To GO
Is it a good idea to have a brokerage account? If you are looking to invest, you will need a brokerage account. Nowadays, brokerage accounts have evolved beyond a holding place for funds. 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.
FAQ
Here are the answers to some of the most frequently asked questions regarding brokerage accounts.
What are the three types of brokerage accounts?
Though there are many types of brokerage accounts, three of the main accounts include standard brokerage, managed brokerage and retirement brokerage accounts.
How much money do I need to open a brokerage account?
The amount of money you would need to open a brokerage account would depend on the company. Some accounts can be opened with no up-front funding but you would need to add funds to purchase investments.
What are the disadvantages of a brokerage account?
A disadvantage to a brokerage account would be the fees. Before selecting your account, make sure you know exactly how much they charge for trades and commissions.
Another disadvantage would be your inability to access your funds on nights or weekends. This can vary by company but you should plan ahead if you know you'll need your funds on a certain day.
Caitlyn Moorhead contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: What Is a Brokerage Account and How Does It Work?
