- Brokerage accounts are financial accounts through which investors hold, buy, and sell various assets.
- Brokerage accounts are offered by broker-dealers, investment companies, and online trading platforms.
- Several types of brokerage accounts exist, serving different needs and with different tax statuses.
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Looking to get started in the stock market? Your first step: open a brokerage account.
Want to open an IRA to build a retirement nest egg, or participate in your company’s 401(k) plan? You have to have a brokerage account.
Feel like trading gold or some other exotic asset? You do so via a brokerage account.
In short, if you want to invest money, instead of just saving it, you need a brokerage account.
Brokerage accounts are a type of financial account that investors use to hold, buy, and sell financial assets and publicly traded securities, like stocks, bonds, and mutual funds. They are held at financial institutions, called brokerages or broker-dealers, whose professionals are licensed to do the actual trading of the assets, under the investor’s direction.
Here’s a brokerage-account-for-beginners guide: how these accounts work, what the different types are, and how you can open one.
What is a brokerage account?
A brokerage account is an investment account: the place where you keep financial products. Like a bank account, they are offered by a financial institution.
But they offer a much wider range of investment options.
Investments you can hold in a brokerage account include:
- Government and corporate bonds
- Mutual funds
- Exchange-traded funds (ETFs)
- Real estate investment trusts (REITs)
Some brokerages also offer access to proprietary investment products, like mutual funds that are exclusive to them or a particular investment firm.
Brokerage accounts and the investments within them are considered liquid assets â€” meaning, they are easily sold and converted to ready money. Don’t confuse them with cash, however.
Your money in traditional bank accounts is available in cash â€” it can be withdrawn immediately. But money in a brokerage account is invested, tied up in individual assets. So if you sell something, it may take a day or two before everything clears and you actually receive the funds.
How a brokerage account works
To invest via a brokerage account, an individual deposits funds with a licensed firm, directing the broker on which assets to invest in. The broker is then responsible for executing an investor’s orders.
The client receives notices of transactions, and monthly statements â€” either paper, or, increasingly, electronically.
Brokerages typically charge annual fees to service and maintain your account. Clients may also be expected to pay commissions on transactions â€” the actual purchase or selling of the securities.
A variety of firms offer brokerage accounts, including traditional broker-dealers, like Edward Jones, Merrill Lynch, and TD Ameritrade; investment companies like BlackRock and The Vanguard Group, which sponsor and manage mutual funds and exchange-traded funds; online trading platforms/apps like Betterment, E*trade, and Wealthfront, and financial services companies like Fidelity Investments and Charles Schwab.
Are brokerage accounts insured?
Yes, brokerage accounts can be insured by the Securities Investor Protection Corporation (SIPC). This coverage means that if the brokerage fails or goes bankrupt, the SIPC will refund or replace your money, up to $US500,000 per account holder. It’s similar to what the FDIC does with bank accounts.
Quick tip: SIPC insurance protects your account, but it doesn’t protect your portfolio. Meaning, it doesn’t apply to losses if your investments perform poorly â€” you losing money because they have dropped in price or value. There’s no insurance that covers that risk. That’s why they call it investing.
Are brokerage accounts taxed?
In most cases, brokerage accounts are taxable. That is, income earned from these accounts is subject to federal and state income tax, in the year they generate it â€” regardless of whether or not it’s actually withdrawn from the account. The same goes for capital gains â€” that is, profits from a rise in your investments. However, you aren’t taxed on these profits until you actually realise them, by selling the investment.
The basic types of brokerage accounts
You can have more than one brokerage account, and different types of brokerage accounts serve different purposes.
- A standard brokerage account is the most common. It is a taxable account that gives investors access to a variety of investments. Investors can trade, deposit, withdraw or shut down their accounts at any time.
- A margin account is a special subset of a standard account. It allows you to borrow money, or margin, from the brokerage to buy stocks and other securities.
- A retirement account is a brokerage account that has special tax status, with money growing in the account tax-free. In many cases, you get a deduction for money deposited in the account as well. Withdrawals are often strictly limited until the investor reaches a certain age. 410(k) plan accounts and IRAs are examples of retirement accounts.
- Education accounts, like 529 savings plans, are commonly used to fund academic-oriented expenses. These are tax-advantaged accounts, and withdrawals are tax-free if used to cover tuition, books, and room and board.
- Custodial accounts are investment accounts for minors, people under the age of 18 or 21, depending on the state. Though held in the child’s name, these accounts are managed by an adult custodian (typically a parent or guardian) until the individual reaches the age of majority.
- Managed or discretionary accounts are like any of the other brokerage accounts with one key difference: They give professional investment advisors the power to manage the account, executing transactions on their own, without checking with the client first. They usually operate using a certain investment strategy.
How to open a brokerage account
When it comes to opening your own brokerage account, the opportunities are endless â€” well, almost. Brokerage accounts can be opened in-person or online, via traditional broker-dealers, investment companies, online trading platforms, and financial services companies.
Fees and balance requirements vary greatly. The exclusively online brokerages tend to be cheaper because they have less overhead than the traditional, bricks-and-mortar firms. Some brokerages require a minimum deposit before opening an account; others let you start at zero.
Here are a few things to look for when evaluating a brokerage:
- Commissions: Some brokerages charge commissions, or transaction fees, whenever you buy or sell any of your holdings.
- Maintenance fees: Many firms charge a small annual amount to maintain and service your account. Note: This is different from the annual fee, called an expense ratio, that a particular mutual fund or ETF often charges you.
- Management fees: These apply mainly to discretionary accounts, the ones in which a professional is actively making investment decisions for you. Their fee is usually structured as a percentage of assets under management.
- Balance requirements: These are minimum account balances that must be maintained to avoid being charged an additional fee.
- Investment options: Not all brokerages offer the same services or types of investments. They might not let you deal in commodities or over-the-counter stocks. So it’s important to make sure the firm you select can accommodate your investment needs.
- Account statements: Most brokerage firms are required to provide account statements detailing completed transactions each month. They are also required to submit tax statements and forms annually â€” copies of information sent to the IRS â€” to help investors prepare their returns.
The financial takeaway
Brokerage accounts give investors the opportunity to buy and sell a wide range of securities. This is the place where you hold your investments, or how you buy and sell them.
Brokerage accounts can be opened via traditional broker dealers, investment companies, online trading platforms, and financial services companies.
Brokerage accounts come in many variations, including standard accounts, retirement accounts, and managed accounts. They can be used to either meet long-term financial needs â€” like money to live on in retirement â€” or to accomplish specific goals, like buying a house or paying for college.
But whatever their form, brokerage accounts all do one basic thing: Make it possible for you to become an investor â€” and start to build your wealth.