In order to invest in stocks, bonds, or mutual funds on your own, you'll need to open a brokerage account. Here's a quick introduction to brokerage accounts, and how to choose the best option for you.
What is a brokerage account?
A brokerage account is a type of financial account that allows you to buy and sell stocks, bonds, mutual funds, currencies, futures, and options (exact offerings vary by broker).
Like a savings or checking account, you can deposit money and withdraw money in your account whenever you'd like, and you can set up automatic transfers. Some brokerages also let you write checks on your investment account, although you can only spend your account's cash balance.
Unlike a savings or checking account, you have the potential to earn high returns, but there is also the possibility that your account's value will go down. There is no FDIC insurance on brokerage account deposits; rather, your account has SiPC coverage that protects you in case your brokerage firm fails (but doesn't protect you against investment losses).
Checklist for opening a brokerage account
1. The first step is deciding what type of account you need: a standard brokerage account or retirement account such as an IRA. An IRA has certain tax advantages, and is designed for money you're specifically saving for retirement. Retirement accounts also have contribution limits. Here's a quick guide to the types of retirement accounts you may be able to open. If the restrictions of retirement accounts (contribution limits, early withdrawal penalties, etc.) don't sound appealing, a standard brokerage account is the way to go.
2. The next step is to compare several online brokers in order to find the one that best meets your needs. When comparing the various brokerage firms, there are a few things to take into consideration:
- Commissions and other fees: Most online brokers charge commissions ranging from $5 to $10 on stock trades, and typically charge additional commissions for option trades. In addition, many brokers have fees for account maintenance, inactivity, and charge interest on margin loans. While a lower commission and favorable fee structure is obviously desirable, keep in mind that this is just one piece of the puzzle. Deeply discounted firms tend to have less in the way of educational resources, support, and access to investment research. Some brokerages offer discounts for more frequent trading, and some charge other fees for other reasons. Make sure you know all of the broker's costs before proceeding.
- Support: Some brokerages have excellent educational resources that can teach you everything you need to know in order to become a successful investor. Others have great trading software that can help active investors tremendously. And, some brokers give you access to premium investment research. In full disclosure, I use TD Ameritrade -- their standard commission of $9.99 is on the high end, but I love their extensive resources, and find their software extremely user-friendly.
- Minimum deposits: Some online brokers have no minimum deposit requirement, while some require $2,000 or more to open an account. This can be a major factor if you're just getting started with investing.
- Incentives: Many brokers offer incentives for opening accounts, especially if you roll over your old 401(k) or open an account with a high initial deposit. For example, as of this writing, E*TRADE offers $200 and 60 days of free trading to customers opening an account with $25,000 to $99,999. Higher deposits get even better incentives.
- Convenience: Most major U.S. banks offer brokerage accounts, and it can be easy to link to your existing checking account. For example, Bank of America offers brokerage accounts through Merrill Lynch, so that's certainly an option worth considering if you bank with B of A. If you bank with another institution, that would be a good place to start your search.
3. Once you've decided on a brokerage firm, go ahead and fill out its new account application. To open an account, you'll need to be at least 18 years old, or you can have your parents set up a custodial account. You'll want to have the usual identifying documents handy, including your driver's license and Social Security card. The broker will also need contact information, details of your employment status, and general information about your net worth.
4. Fund your account. Most brokerages give you several options for making your initial deposit, such as electronic transfers, wire transfers, and mailing a check or money order. When you fund your account, be sure to keep the minimum deposit requirement in mind.
5. Invest. Do your homework, and start building a portfolio of stocks, bonds, and mutual funds that fits your goals and risk tolerance. Reading some of our other content on The Motley Fool is a good idea, especially in our Knowledge Center, which is a great place to learn the basics.
The Foolish bottom line
Opening a brokerage account is the first step toward becoming an investor, and just like any other financial commitment, it's important to thoroughly evaluate your options in order to find the best one for you.