What is a brokerage account and how does it work?
Before you start building your fortune by investing in stocks, you will need to open 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, mutual funds, or other types of assets. So even if you are a self-employed trader working with an online-only broker, you will still need to open a brokerage account.
Here’s everything you need to know about how a brokerage account works.
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 like a bank account you can open at a brokerage. There is no limit on how much you can deposit in a brokerage account, although some accounts limit their insurance to the standard amount of $500,000 provided by the SIPC. You can open as many different types of brokerage accounts as you want, with any number of different brokers. You are not limited to keeping all your money in one company.
Types of Brokerage Accounts
You can choose from several types of brokerage accounts. The best brokerage account for you will depend on your investment needs and goals.
Full-service brokerage account
A full-service brokerage provides clients with a variety of services, including investment advice, retirement planning assistance, and other wealth management services. This type of brokerage account might be the best trading platform for someone who doesn’t have the time or desire to keep up to date with financial news and regulations and wants more services outside of basic trading . However, commissions tend to be higher at full-service brokerages than at discount brokerages.
Here are examples of companies that offer full-service brokerage accounts:
- Morgan Stanley
- Wells Fargo Advisors
Discount brokerage account
Discount brokerages offer stock trading and other investment trading according to the client’s wishes; they do not provide wealth management advice or services. Since discount brokers do not offer the same range of services as full service brokers, their commissions are much lower.
Discount brokerage accounts are a good option for people:
- With sufficient knowledge of the stock market not to need advice
- Who trade often and will benefit from the lower commissions per trade
- Who cannot afford a full service brokerage
Here are some examples of companies that offer discount brokerage accounts:
- Ally Invest
- Loyalty investments
- Robin Hood
- TD Ameritrade
Online brokerage account
Online brokerage accounts are discount brokerage accounts that allow clients to buy and sell investments directly online. Since overhead costs are low for online brokers, commissions are also usually very low. These types can be good brokerage accounts for beginners.
There are many online brokers to choose from these days, including E-Trade, TD Ameritrade, Charles Schwab, and Fidelity Investments. When comparing an online brokerage account, consider the commission charged, whether commission-free trading is available, minimum account balance, and any additional services offered by the broker.
Learn: E-Trade Bank Review: Best for Brokerage Clients
Managed Brokerage Account
Managed brokerage accounts incorporate professional portfolio management for a fee, rather than individual trading commissions. Traditionally, human investment managers allocated client funds based on chosen risk and return parameters. But the new frontier incorporated computer algorithms to allocate customer funds – a process known as robo-advising.
Retirement brokerage account
A retirement brokerage account is a tax-advantaged account designed for long-term investing. Retirement accounts, such as Individual Retirement Accounts, allow you to defer taxes on your investments until you withdraw them after age 59.5. 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.
When choosing your brokerage account, you will also need to choose between a cash account and a margin account. With a cash account, you can only buy securities with the money you have in your brokerage account, or “cash”.
With a margin account, you can borrow money from the broker to invest in securities, but you will have to pay interest on the borrowed money. If the value of your shares drops too much, the broker may sell your shares to repay the loan.
Types of investments a brokerage account can hold
Having a brokerage account allows you to buy and sell many investment products, all of which come with their own risks and rewards. Here are some of the most common investment products:
- Ordinary actions : A common share allows the shareholder to vote at shareholders’ meetings and to receive dividends.
- Favorite stocks: Preferred shareholders receive dividends before common stockholders, and they have priority over common stockholders if the company goes bankrupt and is liquidated. However, they generally do not have the right to vote.
- Obligations : A bond is a loan with set conditions for the borrower to repay the lender. When choosing a bond, the lender must consider the yield, maturity date and rating.
- REITs: A real estate investment trust allows an individual to invest in a large-scale property, such as a shopping mall or an apartment building. REITs are generally considered safe investments with high returns.
- Mutual fund : With mutual funds, a pool of money is collected from many investors which is then used to invest in other securities, such as stocks, bonds and short-term debt.
- AND F : Like mutual funds, exchange-traded funds are a collection of funds from a group of investors that are used to buy other securities. Unlike mutual funds, however, ETFs are traded on an exchange.
- mma: Money market accounts are similar to savings accounts. They generally offer higher interest rates than traditional savings accounts, but they usually require a higher minimum balance and limit the number of withdrawals the account holder can make in a given period.
- 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 which your investment earns interest at a rate that is usually higher than 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 fixed price no later than a specified date. Options trading can involve a range of financial products, including stocks and foreign currencies.
- Cryptocurrency: Not all brokerage accounts support investing in cryptocurrency, such as Bitcoin, but the numbers are growing, especially with online brokers.
How to choose a brokerage account
Since there are countless types of brokerage accounts, you will likely have no trouble finding a large number that will suit your needs. Before choosing, do a self-test to determine what type of investor you are.
Questions to consider
Are you completely self-sufficient and cost-conscious? Then a commission-free online broker might be your best option.
Are you new to investing and probably won’t make many trades per year? In this case, a full-service broker might be a better option, as you can still keep your overall costs low while still receiving investment advice.
If you are opening an account just to trade cryptocurrency, you will need to look for a company that offers this capability. Alternatively, you can compare some of the best crypto exchanges to find a platform that suits your needs.
Opening a brokerage account
Opening a brokerage account is a fairly straightforward process; most financial institutions will allow you to complete the application online. You will generally need to provide the following personal information to open your brokerage account:
- Social Security number
- Date of Birth
- Valid postal and e-mail addresses
- Job information
- General financial information, such as a checking account to fund your brokerage investment account
Once you have opened your account, you can start trading.
Do I need a brokerage account?
A brokerage account is a necessary part of investing. Even if you buy stocks directly from a company or use an investment app to trade, your first step will be to open an account. At the very least, companies need an address to send you important financial statements and your Social Security number so they can report your income to the IRS.
However, a brokerage account is more than just a deposit of funds. Today, brokerage accounts have evolved to offer many features and benefits, from performance tracking to market research and automatic rebalancing. Choosing the right one can greatly improve your overall investing experience.
John Csiszar contributed reporting for this article.
Our in-house research team and on-site financial experts work together to create accurate, unbiased and up-to-date content. We check every stat, quote and fact using trusted primary resources to ensure that the information we provide is correct. You can read more about GOBankingRates processes and standards in our Editorial Policy.