Brokerage account vs. mutual fund: what’s the difference?
Before you start investing, you’ll need to define some key terms and concepts, including the differences between a brokerage account and a mutual fund account. Read on to learn the difference and how each plays a role in your investment strategy.
What is a brokerage account?
A brokerage account is an account you open with a broker or firm that charges you a commission or fee for buying and selling securities. You would use a brokerage account to buy and sell individual stocks or other securities.
If you’re looking for a brokerage account, here are some of our favorites:
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Full Service vs Discount Broker
A number of services you have at a broker depend on the type of broker you signed up with.
An account with a discount broker would likely be very profitable (meaning low commissions) but wouldn’t have much customer service.
An account with a full service brokerage offers more services and could potentially give you access to early IPOs if you have a large account or use their service a lot.
Choose a margin or cash account
In terms of brokerage account types, there are usually two – a cash account and a margin account.
For a cash account, an investor must wait three business days until the trade is settled (a trade being a buy or sell order), before making another trade with the money from the unsettled trade.
For a margin accountthe brokerage lends you money and allows you to complete the transaction instantly.
Since the brokerage firm lends you money, you will have to pay interest on the borrowed money, and this interest is usually 7% or more for accounts under $100,000 at most brokerage firms. brokerage.
Although you can sell short in a margin account but not in a cash account, short selling is considered dangerous and should not be practiced.
To day trade consistently, you usually need to have $25,000 or more, otherwise you’ll run into the day trading rule that you can’t make more than 3 round-trip trades in a week.
Different types of securities you can buy
A brokerage account can be used to buy different types of securities, including common stocks, bonds, mutual funds, etc.
Ordinary actions are essentially just fractional ownership of a company. If the company makes a profit and the management of the company decides to share this profit with its owners, the company could pay a quarterly dividend and you, as an investor, would receive this dividend.
The dividend would go into the brokerage account on the ex-dividend date.
Obligations include items such as treasury bills, municipal bonds and corporate bonds. Because the US government backs treasury bills, short-term treasury bills are considered the safest securities in the world. Municipal bonds are bonds issued by various municipalities and may be tax exempt.
Depending on the strength of a company, corporate bonds may be safer than stocks of the same company. Typically, many bonds pay a coupon or periodic interest payment that continues until the bond matures. This periodic interest payment also goes into your brokerage account.
Opening a brokerage account
To open a brokerage account, you make a request in fill out an application either at a physical broker or online.
Once the broker has verified your credit, work and other information and you are approved, you fund the account via ACH, bank transfer or other means.
Unlike 401(k), IRAs, and other retirement plans, there are no restrictions on how much you can deposit into a brokerage account.
The caveat is that as an investor, you need to check the strength of the brokerage and whether it has SIPC coverage. SIPC coverage is basically insurance that protects investors up to a certain limit if the stock brokerage firm fails for any reason.
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What is a mutual fund?
A mutual fund is similar to a stock that you buy, the only difference being that a mutual fund is a managed portfolio of stocks (or bonds) of many companies.
Since the companies in a mutual fund portfolio are different, a mutual fund can theoretically be less risky than stocks of a single company due to greater diversification.
If things go wrong at one company, other companies in a mutual fund portfolio might still do well, and the mutual fund’s overall net worth, or net asset value, won’t be as negatively affected. As a result, your mutual fund account uses your money to automatically diversify, protect your investment and increase returns.
Typically, mutual funds have a portfolio manager who directs the analysts who do market research. Together, the team does its best to select stocks that they believe will outperform an index, such as the S&P 500, and include it in their portfolio.
Some mutual funds are concentrated in a chosen sector, such as energy or technology, while others cover the entire market. Since professional managers make the buy and sell decisions, mutual funds are considered “active funds”.
Since portfolio managers and analysts bring salaries, many mutual funds charge management fees, which are usually between 0.5% and 2% per year.
In addition to management fees, many mutual funds also charge redemption fees or purchase fees, when an investor leaves and enters the fund, respectively.
Although many mutual funds have outperformed the market for long periods of time, statistics on the overall performance of active funds relative to the broader market are rather sobering.
According to a Standard & Poor’s research report, 92.2% of active large-cap funds, 95.4% of active mid-cap funds and 93.2% of active small-cap funds lag behind a simple index fund that just tracks the S&P 500.
The data suggests that while owning a mutual fund is more beneficial in the long run than staying in cash, owning a simple, low-cost S&P 500 index fund might be a better bet.
A big reason why many mutual funds lag the index is due to mutual fund fees and the fact that some mutual funds make short-term buy and sell decisions, and thus create more taxable income than a buy-and-hold strategy.
In essence, one usually comes before the other
The difference between a brokerage account and a mutual fund is that you generally need a brokerage account before you can purchase a mutual fund, unless your workplace is planning for your retirement.
Looking for an online broker to start investing through a brokerage or with a mutual fund account? Check out our guide on how to start investing, online brokerage rankings, or our picks for the best portfolio trackers.
Frequently Asked Questions
Do you need a brokerage account to buy and sell stocks?
You must have a brokerage account to buy or sell stocks.
What is a margin account?
A margin account allows you to buy or sell stocks using a line of credit given to you by the brokerage firm.