A brokerage account is a financial tool that allows you to invest in stocks, bonds, exchange-traded funds, options and mutual funds. If you’re new to the world of investing, understanding brokerage accounts is one way to begin building a portfolio. Alternatively, new investors can turn to investment professionals and invest in actively-managed strategies -- with or without knowledge of the workings of brokerage accounts.
What is a brokerage account?
A brokerage account is typically used to invest money in financial securities. Unless these assets are held in a tax-deferred account, they are subject to tax, which means that money made in these accounts is taxed as capital gains. While income taxes apply to money earned from employment, dividends, royalties, or interest, capital gains taxes are imposed on profits from trading assets. If you’re confused, consulting with a financial advisor is a good idea. Titan does not offer tax advice.
How does a brokerage account work?
When you open a brokerage account, you’re making an agreement with a registered brokerage firm. Money can be deposited or withdrawn at will, though at times the money is taxable. When you turn over money to your broker, that money can then be invested in securities. How it’s invested depends on the type of account.
3 Types of brokerage accounts
Think of it like choosing a vehicle to get you to a destination. The vehicle needs an operator—it could be you, a hired driver, or a robot.
- Fly solo with an online brokerage account. Online brokerage accounts are self-directed and these days often don’t charge commissions on trades. You decide which securities you want to invest in and when, perhaps based on market trends and your belief in the potential of the investment to increase in value.
- Get a driver with a full-service broker. If you don’t want to pick your own stocks or manage your portfolio, you can hire a broker to steer your investments. The arrangement tends to come with higher fees, both for transactions and managing your account. Still, brokers are professionals with valuable experience with the potential to build wealth for their clients.
- Go on autopilot with a robo-advisor. Like self-driving cars, robo-advisors offer investment advice using technology. These digital advisors don’t answer the phone or work in a physical office—rather, they’re algorithms that invest your money into a diversified portfolio based on your risk tolerance and time horizon. These products tend to charge small fees based on the size of your portfolio, and you can override your robo-advisor’s investment decisions.
Whichever ride you choose, your destination remains the same: investment in securities tied to the market.
How commissions work
Depending on the type of brokerage account, you may be required to pay commissions. A full-service broker makes trades on securities based on how the markets are moving and consults you on those decisions. In this arrangement, you may pay a commission of 1% to 2% per trade, for example. The broker trades on your behalf, but the assets belong to you.
Discount brokers may charge a flat fee of about $5 to $30 per trade, for example, and tend to be less expensive overall. Online brokers, whether self-directed or robo-advisors, frequently charge no commission, but may require custodial fees.
Cash vs. margin brokerage accounts
There’s another way to break down brokerage accounts, based on how you deposit your money:
- Cash brokerage account: For this kind of account, you must deposit cash before it can be invested, whereas others allow leeway for borrowing from the firm for some investments. It’s a fairly barebones approach to trading that doesn’t, for instance, allow you to short a stock, or betting that the shares will fall. The money you deposit is all you can use to invest.
- Margin brokerage account: Unlike a cash account, these let you borrow money from the brokers to make your investments, and you are charged interest on that amount. You can make more sophisticated moves like shorting, but that’s likely not wise for novice investors. Borrowing to make an investment involves a higher level of risk.
What can you invest in with a brokerage account?
Beyond stocks, brokerage accounts enable you to invest in a number of other options:
- Mutual funds: These funds pool money from investors to offer bundles of securities like stocks and bonds.
- Bonds: A bond is a type of loan, or IOU, in which investors lend money to a company or sovereign government. In addition to the principal borrowed, repayment often includes fixed or variable interest.
- ETFs: Short for exchange-traded funds, these track an index like the S&P 500 or another category of asset and function as something akin to an individual stock and a mutual fund. You cannot invest directly in an index.
- Real estate investment trusts: Also known as REITs, these companies own, run, or finance real estate in a portfolio that can cover many property sectors. They allow investors to invest in real estate without purchasing any.
- Cryptocurrencies: An alternative form of payment that is treated like assets, this money goes to digital tokens controlled by a centralized system of computers that rely on blockchain technology for security.
- Certificates of deposit (CDs): Banks and credit unions offer CDs as investment options with higher interest rates than savings accounts. The money must be tied up for a certain amount of time and early withdrawal can result in a penalty.
Each security carries its own level of risk and potential reward, or upside. A financial advisor, be it a human or a robo-advisor, can help you determine which investment path to take.
Brokerage account vs. retirement account
Brokerage accounts are meant for trading securities and their funds can be deposited or withdrawn at will. Retirement accounts, whether offered either by an employer or a brokerage firm, are investment vehicles that are designed to encourage saving for retirement.
How a retirement account invests money is based on your fund, be it your employer’s 401(k) or an IRA (individual retirement account) you choose yourself. These vehicles are tax-deferred, meaning you’ll get tax advantages for withdrawing the money at a later date once you’ve retired. (Note: Unlike brokerage accounts, they carry tax penalties and fees if you withdraw money before a certain age.)
Brokerage account vs. mutual fund
This distinction may be confusing, since a broker can invest in mutual funds. However, it helps to think of a brokerage account as a vehicle and a mutual fund as a destination. The two exist independently of each other, but you often need one to get to the other.
Brokerage account vs. savings account
Savings accounts hold cash, not securities, that pay interest. This money is easy to access, and often is tied to a checking account. However, the yield is typically lower. In contrast, brokerage accounts are used to buy securities and can be used for short- or long-term investing. A withdrawal requires initiating a sale of an asset, which may require fees.
How to open a brokerage account
Opening a brokerage account is simple. You can shop around for a firm to manage your money, whether through a digital operation or a dedicated broker. Here are the broad steps you’ll need to take:
- Choose your brokerage account. Choose the type of account that works with your investing strategy (managed or DIY) and your budget.
- Apply. Opening a brokerage account is simple, but it doesn’t happen with the click of a button. You’ll need to provide identifying information like your name, address, Social Security number (SSN), and bank details if you’re transferring money to your brokerage account electronically.
- Start investing. Robo-advisors and brokers may request additional information about your financial position and goals in order to best direct your investments. Online brokerage accounts that are self-directed allow you to begin trading immediately upon approval.
Whichever path you choose, opening a brokerage account is one move to consider as you work on growing and maintaining your wealth.
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