A brokerage account allows you to buy and sell stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Brokerage accounts are also called taxable investment accounts—to differentiate them from tax-advantaged retirement accounts like individual retirement accounts (IRAs) and 401(k)s. Full-service brokers, discount brokers, and online brokers are places where you can open a brokerage account.
How Does a Brokerage Account Work?
You deposit cash in a brokerage account and use the funds to purchase stocks, bonds, mutual funds, and ETFs, as well as a host of investment assets. People use brokerage accounts to day trade and earn short-term profits, or invest for long-term goals. Many brokerage accounts also provide ways to earn a decent yield on uninvested cash.
A brokerage maintains your brokerage account and acts as the custodian for the securities you own in your account. The brokerage is the intermediary between you and markets, buying and selling investments on your instructions.
Brokerage accounts are offered by a wide range of firms, from full-service brokers with a complete menu of financial services, to automated robo-advisors and online brokers. Fees and requirements vary accordingly: There may be a minimum balance required to open a brokerage account, some firms may charge management fees and there may be trading commissions to buy or sell certain assets.
Is my money safe in a brokerage account?
Cash and securities in a brokerage account are insured by the Securities Investor Protection Corporation (SIPC). The insurance provided by SIPC covers only the custodial function of a brokerage: It replaces or refunds a customer’s cash and assets if a brokerage firm goes bankrupt. SIPC protects $500,000 per customer, including only up to $250,000 in cash. SIPC does not protect you from bad investment decisions or a loss in value of your investments, either due to your own choices or poor investment advice.
Margin Account vs. Cash Account: What’s the Difference?
There are two main types of brokerage accounts: cash accounts and margin accounts. The difference between them is how you purchase your investments.
What Is a Brokerage Cash Account?
When you have a cash account at a brokerage, you buy securities with the money deposited in the account. “If you have $100, you can only buy $100 worth of stock,” says Matthew Boersen, a certified financial planner in Jenison, Michigan. If you don’t have more money in your account, you can’t purchase additional securities.
What Is a Brokerage Margin Account?
With a margin account, you can borrow money to buy investments, and the investments themselves are collateral for the loan. “If you have $100, you could potentially buy more than $100 worth of stock,” Boersen says. “The custodian will give you a loan so you can buy additional stock. You have to pay interest on the loan, but it’s a loan internally, inside your account.”
A margin account allows you to execute more complex trading strategies, such as short selling, but there are risks to using debt, instead of cash, to invest. For instance, if the value of your investments falls, your brokerage firm may ask you to pay back your margin debt immediately—this is known as a margin call. The firm also has the right to sell any of the investments in your portfolio, without advance notice, to cover an account deficit.
Brokerage Accounts vs. Retirement Accounts
Brokerage accounts and retirement accounts both can help you save for the future by providing a way to invest your money in the financial markets. However, there are big differences between these types of accounts, especially when it comes to the range of investing options they offer and tax treatment.
Brokerage Account Flexibility
Brokerage accounts lack the rules and restrictions that govern retirement accounts, like 401(k)s and IRAs, among others. Annual contributions to retirement accounts are capped, there are strict rules on when you can withdraw funds and some retirement accounts may offer a limited choice of investable assets and securities. The latter is especially true in 401(k) accounts.
Brokerage accounts offer much greater flexibility. You may deposit as much money as you want in a brokerage account, and you can invest in any of the assets or securities offered by your broker. “You can put the money in whenever you want, take the money out whenever you want,” Boersen says. “And there’s really no limit on what the investment options are.”
Brokerage Account Tax Treatment
Brokerage accounts and retirement accounts are taxed differently. Contributions to traditional IRAs and regular 401(k)s are made before you pay income taxes on your salary, the balance grows tax-free over time and you pay taxes when you withdraw money in retirement. With Roth IRAs and Roth 401(k)s, contributions are made after you have paid income taxes, the money grows tax-free over time and you pay no taxes when you withdraw funds in retirement.
With brokerage accounts, when you sell an investment for a gain, you pay capital gains taxes. Generally, if you’ve held the investment for more than a year, you’ll pay the long-term capital gains tax rate on the proceeds and if you’ve owned it for less than a year, you’ll pay the short-term capital gains tax rate.
You will owe taxes when you receive income from investments held in your brokerage account, such as dividends or interest, or when cash in your account earns interest. If a stock you own pays out cash dividends or qualified dividends, the proceeds may be taxed. Taxes on interest income from bonds are more complicated.
One tax strategy available to investors with a brokerage account is called tax-loss harvesting. Under certain conditions, when you sell an investment for less than you paid for it, you may use some of the loss to offset other taxable gains in your portfolio.
If you invest strategically using your brokerage account, you can minimize the taxes you’ll owe. “For some people, the brokerage account may be equally as beneficial as some of the retirement accounts, if managed correctly from a tax standpoint,” Boersen says.
Where Can You Get Brokerage Accounts?
You can open a brokerage account with these different kinds of brokers:
- Online brokers. For self-directed investors, an online brokerage account lets you manage your investing portfolio yourself, with little or no guidance from algorithms or professionals. “You open up the account and you self-select your investments,” says Jennifer Weber, a certified financial planner in Lake Success, New York. Online brokerage accounts offer the lowest fees and low to zero trading commissions. Wells Fargo, for instance, offers an online brokerage account where you’ll pay $0 commissions to trade stocks and ETFs online or by automated telephone trading.
- Robo-advisors. For hands-off investors or people who are new to investing, robo-advisors make things easy with algorithmic investing and occasional human assistance. Consumers answer a few questions about their financial goals, timeline and risk tolerance, and a robo-advisor will use a computer program to design a diversified portfolio tailored to your needs, usually comprising ETFs or low-cost mutual funds. These types of brokerage accounts typically come with fees, but they’re on the lower side, with firms like Wealthfront and Betterment charging 0.25% per year for digital portfolio management.
- Managed accounts. Full-service brokers and financial advisors offer brokerage accounts that are managed by financial professionals. “These are traditional advisors, who really get to know you and your circumstances, and then make a selection of investments based on your current situation and goals,” Weber says. In a managed brokerage account, you may get access to advice about other aspects of your financial life, such as estate and retirement planning. Fees on this kind of account will be the highest, with average registered investment advisors charging an annual fee of 1.17% of assets under management.
What Kind of Brokerage Account Should You Choose?
Choosing a brokerage account depends on your investing experience, the amount of time you can devote to managing your portfolio and how much you want to pay.
“If you’re somebody who wants to keep it super simple and buy a single stock or a single fund, or if you’re willing to do your own legwork and make your own choices, you may decide that an online brokerage would be the best choice,” Boersen says.
A downside to the self-directed approach with an online brokerage is that when the market gets tough, there’s no one around to keep you from reacting emotionally and making poor investment decisions. For instance, big market dips can drive unseasoned investors to sell their investments, which is often a suboptimal choice.
On the other hand, working with a financial advisor or a full-service broker gives you access to professionals with deep understanding of markets and investing. When you take full advantage of managed brokerage accounts, you help ensure your portfolio matches a plan and goals you and a professional have developed together. The right investment professional “can help delineate between the millions of investment strategies out there and determine the best one for the client,” Boersen says.
Robo-advisors fall somewhere in the middle. They’re great for someone who doesn’t want to make all the decisions themselves and yet isn’t ready to pay higher prices for a managed brokerage account.
How to Open a Brokerage Account
You can open a new brokerage account in a matter of minutes, provided you have the funds to make the initial deposit. Just be prepared to answer some questions and provide some personal information during account setup.
“It’s easier than people think it is,” Boersen says. “Sometimes people get scared or overwhelmed by some of the questions, but most brokerage platforms have call support or chat functions to guide you through the process.”
You will need to provide personal information to open a brokerage account, such as:
- A Social Security number or a Tax Identification Number
- A driver’s license or passport, or other government-issued ID
- Information on your employment status
- Financial information, such as your annual income and net worth
- A basic overview of your investment objectives
Unsure of how to choose a brokerage account? Here are two tips:
- Compare account offers. For online brokers and robo-advisors, pay attention to fees, fund selection and how user-friendly you find their website. Do you meet the minimum account requirements? Is there access to human help if you need it? Check out at least three different brokerages and read online reviews.
- Ask friends and colleagues. If you’re looking for a managed account or financial advisor, ask people you know if they’ve worked with someone they would recommend. Meet with brokers or advisors in person to see how you mesh. “It’s important to meet with different advisors and really understand their philosophy and how they work as a team,” Weber says. “Are they a team, or is it just an individual person? Who’s selecting the investments? Do they offer you financial planning?”
A brokerage account is a key part of your financial plan, as investing in markets is one of the best ways to achieve long-term growth. It’s important that you work with a company or person you can trust, because it’s your money and you are investing in your future.