Brokerage account definition
What is a brokerage account?
A brokerage account is an arrangement in which an investor deposits money with a licensed brokerage firm, which transacts on behalf of the client.
Although the brokerage executes the orders, the assets belong to the investors, who generally must claim as taxable income any capital gains realized on the account.
Key points to remember
- Investors have different needs and should choose their brokerage firms accordingly.
- Investors who need a lot of advice and support may benefit from aligning with a full-service brokerage firm, which charges higher fees.
- Full-service companies charge either a flat fee for their service, depending on the size of the account, or commissions on the trades they execute.
- Online brokers charge lower fees and are suitable for investors who want to conduct their own trades.
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Understanding Brokerage Accounts
There are several types of brokerage accounts and brokerage firms, giving investors the flexibility to choose the model that best suits their financial needs. Some full-service brokers provide in-depth investment advice and charge exorbitant fees for that advice.
At the other end of the compensation spectrum, most online brokers simply provide a secure interface through which investors can place trade orders, and they charge a relatively low fee for this service. Brokerage accounts can also differ in terms of order execution speed, analytical tools, scope of tradable assets, and the extent to which investors can trade on margin.
In any type of brokerage, the most basic type of account is a cash account. This allows clients to purchase shares using money deposited in the account. However, you cannot sell short, buy on margin, or trade options or other more sophisticated products. To do these things, you need a margin account instead. With a margin account, any cash shortfall will be lent to you by your broker. The broker will charge you regular maintenance interest on this loan, and they may require you to add money if the account loses too much value, which is called a margin call. If you cannot meet a margin call, your broker may be forced to sell securities in your account.
Full Service Brokerage Accounts
Investors seeking the expertise of a financial advisor should align themselves with full-service brokerage firms such as Merrill, Morgan Stanley, Wells Fargo Advisors, and UBS. Financial advisors are paid to help their clients develop investment plans and execute trades accordingly. Financial advisors work either on a non-discretionary basis, where clients must approve transactions, or on a discretionary basis, which does not require client approval.
Full-service brokerage accounts charge either transaction commissions or advisor fees. A commission account generates a fee each time an investment is bought or sold, whether the referral comes from the client or the advisor, and the trade is profitable.
In contrast, advisor fee accounts charge a flat annual fee, ranging from 0.5% to 2% on the total account balance. In exchange for these fees, no commission is charged when buying or selling investments. Investors should discuss compensation models with financial advisors at the outset of relationships.
Do-it-yourself traders should be careful when trading low-volume stocks, which may not have enough buyers on the other side of the trade, to unload their positions.
Discount brokerage accounts
Investors who favor a self-directed investing approach should seriously consider using discount brokerage firms, which charge significantly lower fees than their full-service brokerage counterparts. However, as their name suggests, discount brokerage firms such as Charles Schwab, TD Ameritrade, E*TRADE, Vanguard, and Fidelity offer less service in exchange for lower fees. This, however, may be ideal for investors who primarily want to execute low-cost investment transactions through easy-to-use online trading software.
For example, an investor who signs up with a typical discount broker can expect to open a regular taxable brokerage account or a retirement account at no cost, as long as they are able to fund the account with a $500 open minimum. To buy or sell most stocks, options or exchange-traded funds (ETFs), there is little or no commission. Some discount brokers may charge a fee for non-US stocks or thinly traded stocks, but this varies from broker to broker.
Treasury bills generally require no commission to trade, but secondary bonds can vary. Many brokers such as Schwab, Fidelity, and E*TRADE also offer a wide variety of mutual funds with no transaction fees.
Brokerage accounts with a regional financial advisor
Some investors prefer the personal interaction of a full-service broker, but also want a more personalized approach while working with a firm that feels more localized in the investor’s community. These investors generally consider using a middle ground between full-service brokerage firms and discount brokerage firms – firms such as Raymond James, Jefferies Group LLC, or Edward Jones. They act both as brokers and financial advisers. This group requires a larger minimum account size and caters to people with slightly higher net worth, but over time their services tend to be cheaper than the larger brokerages.
Online brokerage accounts and downward pressure on prices
Launched in early 2015 under a mobile-only platform, online brokerage Robinhood offers commission-free trading and has no minimum account requirements except for its margin accounts. Although it bypasses commissions, the company pioneered the ability to generate revenue from a practice known as payment for order flow (PFOF).
Market-making firms that focus on connecting buyers and sellers through electronic communication networks (ECNs) need a steady flow of retail investor orders to match buyers and sellers. institutional sellers. Therefore, companies such as Citadel Securities or IMC find it useful to create an incentive for brokers to bring orders to them. Paying brokers like Robinhood for the right to execute client trades improved their speed and accuracy of execution and made Robinhood’s business model possible.
The amount paid by the market making firm is far less than typical stock trading commissions were (on a per trade basis), so even though this cost is ultimately passed on to the consumer as an embedded fee, this model always benefits the consumer due to its lower cost and efficiency. By the end of 2019, almost all discount brokerage firms have fully embraced this business model and moved to free commissions on most stock trades.
Commission-free brokerage accounts
In November 2017, Robinhood announced that it had surpassed 3 million brokerage accounts, surpassing $100 billion in trading volume. Meanwhile, E*TRADE reported about 3.5 million brokerage accounts, with $311 billion in assets under management (AUM).
There are downsides to free trading. Case in point: Robinhood does not offer investment advice typically available from traditional brokerages. Robinhood also does not currently support annuities or retirement accounts. Company officials say they may back the latter in the near future. But even so, Robinhood’s model has proven to be so successful that by the end of 2019, major discount brokers switched to a commission-free model for most stock trading, demonstrating that customers prefer such an approach.
How can I open a brokerage account?
Today, it is quite simple and quick to open a brokerage account via the Internet. You will need to register and provide some required personal information such as your address, date of birth, and social security number. Today, account approvals are fast and the next step is to fund your new account, which can also be done online via the Automated Clearing House (ACH) or by wire transfer.
Is it dangerous to have a margin account?
Margin allows investors to do more than with a cash account. These include selling short and buying on margin. These activities are inherently riskier than simply buying stocks, but they can also generate additional returns. Having a margin account is only dangerous if you get too leveraged in either direction. This is because a margin call caused by a severe event like a short squeeze can wipe out his account quite quickly.
Can I have multiple brokerage accounts?
Yes, although it may not be ideal to have your assets invested in multiple places where they may overlap or even contradict each other. You can choose to have a broker for long-term investing while opening a trading account for more speculative or short-term games.
Which brokerage accounts allow me to trade for free?
Since Robinhood opened the doors to commission-free trading, dozens of online brokerage platforms have followed suit. These include big names such as Schwab, TD Ameritrade, E*TRADE and Fidelity.
How is a brokerage account different from a bank account?
Brokerage accounts are intended to hold securities such as stocks, bonds, and mutual funds. Although a brokerage account may also hold cash, the purpose of these funds is to be available to purchase additional securities or to create a small cash cushion.
A bank account, on the other hand, can only hold cash deposits. With a bank account, you can also often write checks or use a debit card. Today, some brokerage accounts also allow you to use a debit or check writing feature.
Another difference is deposit insurance. Many bank accounts are insured by the Federal Deposit Insurance Corp. (FDIC) up to $250,000. Brokerage accounts are not insured in the same way, but they are generally covered by the protection of Securities Investor Protection Corp. (SIPC), which can help recover some of the value of these accounts if a brokerage fails.