What Is a Brokerage Account? Definition, How to Choose, and Types (2024)

What Is a Brokerage Account?

A brokerage account is an investment account held at a licensed brokerage firm. An investor deposits funds into their brokerage account and the brokerage firm transacts orders for investments such as stocks, bonds, mutual funds, and exchange-traded-funds (ETFs) on their behalf.

The assets in investment accounts belong to the investors, who normally must report as taxable the income derived from the account.

Key Takeaways

  • Investors have different financial and investment needs and should choose their brokerage firms accordingly.
  • Investors who desire advisory services may benefit from a full-service brokerage firm, which charges higher fees than other brokerages.
  • Full-service firms charge either a flat fee based on the size of the account or commissions on the trades that they execute.
  • Online brokerages charge lower fees and may suit investors who wish to conduct their own research, trades, and other account transactions.
  • Robo-advisors offer financial planning, investing, and portfolio management using algorithms and minimal human intervention.

Understanding Brokerage Accounts

There are multiple types of brokerage accounts and brokerage firms, giving investors the opportunity to select the model that best suits their financial needs.

Some full-service brokers provide extensive investment advice and other services, and charge high fees. On the other end of the compensation spectrum, most online brokers simply provide a secure interface through which investors can place trade orders. They charge relatively low fees for this service. Robo-advisors are digital platforms that offer financial planning and investment services driven by algorithms, not people. Typically, they are low cost and require low account opening minimum amounts.

Brokerage accounts may differ in terms of order execution speed, analytical tools, the scope of tradable assets, and the extent to which investors can trade on margin.

In any type of brokerage, the most basic account is a cash account. This allows clients to buy investments using the money deposited in the account. However, you cannot sell short, buy on margin, trade options, or take advantage of other more sophisticated products. To do so, you need a margin account.

With a margin account, you can get a loan from your brokerage for additional purchases. The securities in your account serve as collateral. The brokerage charges regular maintenance interest on this loan, and it may request additional money from you immediately if the securities in the account lose too much value. This request is known as a margin call. If you cannot meet a margin call, your broker may be forced to sell securities in your account.

Types of Brokerage Accounts

Full-Service Brokerage Accounts

Investors seeking the expertise of a financial advisor can consider full-service brokerage firms such as Merrill, Morgan Stanley, Wells Fargo Advisors, and UBS, among others. Financial advisors are paid to help their clients develop investment plans, execute their transactions, monitor their investments and the markets, and more. Financial advisors work on either a nondiscretionary basis, where clients must approve transactions, or a discretionary basis, where transactions don't require prior client approval.

Full-service brokerage accounts charge either commissions on trades or advisor fees. A commission account generates a fee anytime an investment is bought or sold, whether the recommendation came from the client or the advisor, and whether the trade is profitable or not.

By contrast, an advisor fee account involves flat annual fees ranging from 0.5% to 2% of the total account balance. In exchange for this fee, no commissions are charged when investments are bought or sold. Investors should discuss compensation models with financial advisors at the onset of relationships.

Do-it-yourself traders should be careful about trading low-volume stocks, which may not have enough liquidity to allow investors to enter or exit positions easily.

Discount Brokerage Accounts

Investors who favor a do-it-yourself investment approach might consider a discount brokerage firm. These firms charge significantly lower fees than their full-service counterparts. However, discount brokerage firms (such as Charles Schwab, TD Ameritrade, E*TRADE, Vanguard, and Fidelity) offer fewer services in exchange for these lower fees. This, though, may suit investors who are most concerned with keeping costs low and executing trades via easy-to-use online tradingplatforms.

For example, an investor who decides on a typical discount broker can expect to open a regular taxable brokerage account (or retirement account) with a $500 minimum required amount. There is little or no commission charged to buy or sell most stocks, options, or ETFs. Some discount brokers may charge fees for non-U.S. stocks or thinly traded stocks, but this varies from one broker to the next.

The purchase of Treasury bonds typically involves no commission (but bonds traded in the secondary market may). Many brokers, including Schwab, Fidelity, and E*TRADE, offer a wide variety of mutual funds for no transaction cost as well.

Robo-Advisor Accounts

Robo-advisors are accounts where they, and not the account holder, select the investments using algorithms and without human participation. Moreover, those investments are usually restricted to mutual funds or ETFs. The cost can be around 0.25% of assets under management (AUM) per year. Required minimum amounts to open an account can range from $0 to $500 to $5,000 and up. Robo-advisors might be right for people who are new to investing as well as experienced investors who prefer a hands-off approach to portfolio management.

Brokerage Accounts With a Regional Financial Advisor

Those investors who prefer a personal relationship and a choice of services may also want to work with a brokerage firm that's part of their own community. They can consider a regional firm that falls between full-service brokerage firms and discount brokerage firms on the cost scale. Such companies include Raymond James, Janney Montgomery Scott, and Edward Jones.

These brokerages act as broker-dealers and financial advisors. They can require a sizeable minimum account size and cater to individuals with a slightly higher net worth than other brokerages. Over time, though, their services tend to be less expensive than larger, full-size brokerages.

OnlineBrokerage Accounts

Online brokerages are a good choice for investors who prefer to select their own investments and execute their own trades via a website or mobile app. However, many also offer research and analysis tools to help investors make informed decisions. Many charge a per-transaction commission. Some charge no commissions.

Robinhood is an online broker that offers commission-freetrading on stocks, ETFs, and options. The firm generates its revenue from payment for order flow (PFOF), margin interest, income from cash holdings, and more. PFOF is compensation a brokerage receives for directing trades to a specific market maker. The amount paid is usually a fraction of a penny per share.

Other zero-commission brokers include Charles Schwab, Fidelity, E*Trade, Vanguard, and TD Ameritrade.

Cash Brokerage Accounts

A cash brokerage account requires you to deposit cash in order to start trading. This account limits your options to the basics such as purchasing stock. For example, short-selling a stock is not possible within cash accounts. Cash accounts can be either discount or full-service accounts.

Margin Accounts

A margin account allows you to borrow money to start trading. The broker acts as a lender, and the borrowed funds allow for larger trades and more advanced trades, such as short-selling a stock. The investor pays interest on the loaned amount of money. The brokerage may demand an immediate deposit of funds from an investor if the value of their account drops below a specified level due to market behavior.

Margin accounts can also be discount or full-service brokerage accounts. While a margin account offers you more flexibility, there is some risk involved. If you are new to investing, it's best to stick with a cash account at first.

To choose the best brokerage for your needs, consider your investing style, your short- and long-terms goals, the types of investments you seek, and the level of service and support you want. Cost may drive the choice for some investors, whether they're novices or highly experienced.

How to Open a Brokerage Account

Opening abrokerageaccount is a simple process that takes just a few minutes. Once you've selected a firm and the type of account you want to open (taxable or tax-advantaged), get the following personal information ready:

  • Your Social Security number (or Tax Identification Number)
  • Your driver’s license, passport, or other government-issued ID
  • Employment information
  • Financial data (e.g., annual income, net worth)

The setup process will include questions about your financial needs, investment goals, investing style, and tolerance for risk.

Once you've created your profile and your account is open, you’ll need to fund your account.

Remember, to open an account, you have to have selected the brokerage that suits your needs. If you're still unsure, step back and consider, for instance, whether you're an engaged investor who follows the markets daily. Or someone who wants to leave that to others. Do you take a conservative (income-focused) or aggressive (growth-focused) approach to investing? Are you investing for short-term goals or retirement? How easy is it to use a broker's website? Understanding such topics can help you choose a firm as well as decide on whether to open a taxable brokerage account or a tax-advantaged retirement account.

Standard Brokerage Account vs. IRA Brokerage Account

Investors can open a standard brokerage account and an IRA brokerage account. In fact, you can open an IRA even if you already have a workplace retirement plan, such as a 401(k). That's a great idea because it gives you an additional tax-advantaged opportunity to save for retirement.

Knowing the difference between a standard brokerage account and an IRA account opened at a brokerage can help you decide whether you should open one or the other—or both.

Standard Brokerage Account

  • The standard brokerage account is a taxable account.
  • You can deposit as much money as you wish, as often as you wish.
  • Deposits are not tax deductible and, for the most part, earnings on your investments are taxable as capital gains.
  • You can invest in any securities offered by your brokerage.
  • Beyond deposits, the account's flexibility extends to withdrawing funds at any time.
  • It's used for all kinds of purposes, e.g., to build wealth over the long-term and reach short-term financial goals, such as buying a home.

Brokerage IRA Account

  • An IRA account is a tax-advantaged account.
  • You're restricted to an annual contribution cap.
  • A traditional IRA allows for tax-deductible contributions but investors pay income taxes on withdrawals in retirement. A Roth IRA involves after-tax contributions (meaning, they are not tax deductible) but investors can withdraw tax-free money in retirement.
  • Earnings in an IRA grow undiminished by taxes.
  • You can invest in a wide range of securities offered by your brokerage.
  • Beyond the restriction on contribution amounts, IRAs have regulations governing when you can withdraw funds, without penalty.
  • It's used to invest for long-term retirement savings goals.

How Can I Open a Brokerage Account?

Opening a brokerage account online is a fairly quick and easy process. You have to register on the brokerage site and provide some required personal information such as your address, date of birth, and Social Security number. Account approvals happen fast, and the next step is to fund your new account, which also can be done online via Automated Clearing House (ACH) or wire transfer.

Is It Dangerous to Have a Margin Account?

A margin account involves more risk than a cash account where you buy shares of stock with your own money. A margin account is dangerous if you borrow too much and the market turns against you. A resulting margin call for additional money may be difficult for you to meet. Brokers can sell securities in your account to meet the call if you don't deposit the funds.

Can I Have Multiple Brokerage Accounts?

Yes, although there are pros and cons to having your assets invested in several places. You can have multiple accounts at a single broker. Or you might choose to, for example, use one broker for long-term investing and another for trading or short-term plays.

Which Brokerage Accounts Let Me Trade for Free?

Since Robinhood opened the doors to commission-free trading, dozens of online brokerage platforms have followed suit. These include major names such as Schwab, TD Ameritrade, E*TRADE, and Fidelity. Some fees other than trading commissions may apply.

How Does a Brokerage Account Differ From a Bank Account?

Brokerage accounts hold securities such as stocks, bonds, and mutual funds and some cash. A bank account only holds cash deposits. A bank account lets you write checks and use a debit card. Some brokerage accounts also provide a debit card and allow you to write checks. Many bank accounts are FDIC-insured for up to $250,000. Brokerage accounts usually have SIPC protection, which can help recover some value of such accounts if a brokerage goes under.

The Bottom Line

A brokerage account is an investment account that investors open at a brokerage firm and use to buy and sell investment securities. They can be a key to wealth-building.

Brokerage accounts can be used to purchase, hold, and sell stocks, bonds, mutual funds, ETFs, and more. Investors can open a standard brokerage account and/or an IRA brokerage account, in addition to having a retirement plan at work, to maximize their saving and investing opportunities.

As an enthusiast with a deep understanding of brokerage accounts and investment practices, I'll provide a comprehensive breakdown of the concepts mentioned in the article "What Is a Brokerage Account?"

Brokerage Account Overview:

A brokerage account is essentially an investment account held at a licensed brokerage firm. Investors deposit funds into these accounts, and the brokerage firms then execute orders for various investments, including stocks, bonds, mutual funds, and ETFs, on behalf of the investors.

Key Takeaways:

  1. Diverse Financial Needs:

    • Investors have different financial and investment needs, and they should choose brokerage firms accordingly.
  2. Full-Service Brokerage Firms:

    • Offer extensive investment advice and services, often charging higher fees.
    • Compensation models include flat fees or commissions on trades.
  3. Online Brokerages:

    • Charge lower fees, suitable for investors who prefer self-research and transactions.
    • Provide a secure interface for trade orders.
  4. Robo-Advisors:

    • Utilize algorithms for financial planning, investing, and portfolio management with minimal human intervention.

Types of Brokerage Accounts:

  1. Full-Service Brokerage Accounts:

    • Offered by firms like Merrill, Morgan Stanley, etc.
    • Financial advisors provide investment plans, execute transactions, and monitor investments.
    • Compensation: Commissions on trades or flat annual fees.
  2. Discount Brokerage Accounts:

    • Firms like Charles Schwab, TD Ameritrade, etc.
    • Lower fees, fewer services.
    • Suitable for cost-conscious investors who prefer easy-to-use online platforms.
  3. Robo-Advisor Accounts:

    • Digital platforms using algorithms for investment selection.
    • Low cost, low account opening minimums.
    • Ideal for hands-off portfolio management.
  4. Brokerage Accounts with Regional Financial Advisors:

    • Regional firms like Raymond James, Janney Montgomery Scott.
    • Personalized services with a slightly higher net worth requirement.
  5. Online Brokerage Accounts:

    • Ideal for investors who prefer selecting and executing their own trades.
    • Offer research and analysis tools.
    • Some charge commissions, while others, like Robinhood, offer commission-free trading.
  6. Cash Brokerage Accounts:

    • Require cash deposits to start trading.
    • Limitations on trading options compared to margin accounts.
  7. Margin Accounts:

    • Allow borrowing money for larger and more advanced trades.
    • Risk involved, with the potential for margin calls.

Opening a Brokerage Account:

  • Requirements:

    • Social Security number or Tax Identification Number.
    • Government-issued ID.
    • Employment and financial information.
  • Considerations:

    • Align the choice of brokerage with your investing style, goals, and preferences.
    • Decide between taxable and tax-advantaged accounts based on your needs.

Standard Brokerage Account vs. IRA Brokerage Account:

  1. Standard Brokerage Account:

    • Taxable account with no contribution limits.
    • Deposits are not tax-deductible, and earnings are taxable as capital gains.
    • Flexibility in using funds for various purposes.
  2. Brokerage IRA Account:

    • Tax-advantaged account with annual contribution limits.
    • Traditional IRA involves tax-deductible contributions; Roth IRA involves after-tax contributions.
    • Primarily used for long-term retirement savings.

Opening and Managing Brokerage Accounts:

  • Process:

    • Simple online registration.
    • Provide personal information.
    • Answer questions about financial needs, goals, and risk tolerance.
  • Managing Multiple Accounts:

    • Possible but with pros and cons.
    • Consider having accounts at a single broker or diversifying across brokers based on your investment strategy.

Frequently Asked Questions:

  1. Danger of Margin Accounts:

    • Involves more risk than cash accounts; margin calls can be challenging to meet.
  2. Multiple Brokerage Accounts:

    • Possible with pros and cons; consider based on your investment strategy.
  3. Commission-Free Trading:

    • Many online brokers, including Robinhood, Schwab, TD Ameritrade, E*TRADE, Fidelity, offer commission-free trading.
  4. Difference from Bank Account:

    • Brokerage accounts hold securities, while bank accounts hold cash deposits.
    • SIPC protection in brokerage accounts compared to FDIC insurance in bank accounts.

Conclusion:

In conclusion, understanding brokerage accounts involves considerations of individual financial goals, risk tolerance, and preferred levels of service. Selecting the right brokerage and account type is crucial for optimizing investment opportunities and building wealth effectively.

What Is a Brokerage Account? Definition, How to Choose, and Types (2024)
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