Types of brokerage accounts
In addition to the various types of brokerages, there are several different options among brokerage accounts. Here's how some of those accounts differ:
Taxable accounts
A taxable account is the main kind of account that most brokerages offer. In it, you buy and sell securities, generating capital gains and losses that are subject to taxes. Fortunately, the tax code allows us to offset gains with losses, thereby shrinking our tax hit.
Tax-advantaged accounts
Many brokerages, as well as mutual fund companies and other financial services companies, let you open tax-advantaged accounts such as an individual retirement account (IRA) -- both traditional and Roth. Some are also in the business of administering 401(k) plans for various employers. Thus, you might have a taxable account at a brokerage, as well as an IRA at the same one or another, and also a 401(k) through your job that's being administered through a brokerage.
Cash vs. margin accounts
Many brokerage accounts need to be designated as cash or margin. A cash account is the simplest option and will serve most investors just fine. It requires that you have the cash in your account to cover the investments you make. Want to buy $2,000 of stock in a company? You need $2,000 in the brokerage account -- plus enough to cover the cost of the commission. If you sign up for a margin account, though, you can invest in various securities with money that you borrow from the brokerage "on margin." Using margin will amplify both your gains and losses, so while it can be enticing, it also can be disastrous. Proceed with caution if considering a marain account or just avoid it entirely.
There are other kinds of brokerage accounts, too, such as ones cleared for options trading, joint accounts, custodial accounts for kids, rollover IRA accounts formed with funds from an old 401(k) account, and so on.
Learn more: Cash Account vs. Margin Account: What's the Difference?
Why do I need a broker?
You might wonder whether you really need a brokerage account, especially if you're a beginning investor. How exactly does the brokerage account help you invest?
The answer lies in the mechanics of investing. Without a brokerage account, if you want to buy a certain amount of stock in a company, then you have to somehow find another investor who happened to want to sell exactly that number of shares of the stock. Then you'd have to agree on a price. That's a lot of work.
To make things easier, financial exchanges bring buyers and sellers together. But only members of a given exchange can use it to conduct business. By opening a brokerage account with a broker that's a member of the major financial exchanges, you agree to have your broker act as your intermediary in making trades.
It's because of this relationship between you and your broker that you have to be very precise when you tell your broker exactly how you want to invest.
Types of orders
There are many different types of orders you can use in your brokerage account that will get you the results you want:
- Market orders tell brokers to buy or sell at the best price they can get. You definitely end up making the trade, but you have no guarantee what the trade price will be.
- Limit orders tell brokers to buy or sell at the limit price you specify in the order. You therefore know that if the trade goes through, you'll get that price. But there's no guarantee that your broker will find anyone willing to take the other side of your trade.
- Stop orders tell brokers to take action only if the price of the investment hits a certain level. For instance, if you own a stock currently worth $25 and place a sell stop order for $20, your broker only sells your stock if the price drops to $20 or below.
- Fill-or-kill orders execute immediately or they're cancelled.
- Day orders remain active all day until filled, and if they're not filled, they automatically cancel at the end of the day.
- Good-til-cancelled orders stay in effect indefinitely, usually subject to a 60-day or 90-day limit defined in your brokerage account agreement.
What to look for in a brokerage account
If you want the best brokerage account, it's smart to look for the characteristics that are most important for you. Some things to look for in a brokerage include the following:
- Low costs: Look for brokers that charge zero commissions for stock and ETF trading and have few or no ancillary fees for things like account maintenance. Also look for reasonable commissions for mutual fund investments if you plan on going that route. That way, more of your hard-earned money will go toward building the value of your investments over the long-term.
- Appropriate investment minimums: If you're just starting out, you might not have that much money to invest. That's not a problem with most brokerage companies, but a few have a hefty minimum deposit requirement. If you don't meet the requirement, these brokers either charge a low-balance fee or prevent you from opening an account entirely.
- Full range of account types: In addition to a regular investment account (also known as a taxable brokerage account), you might benefit from having IRAs (traditional and Roth IRA account types), other types of retirement accounts, health savings accounts, and other tax-favored specialty accounts. Many brokers offer these tax-favored accounts, but not all do, so be sure to check before you open an account.
- Non-stock offerings: If you're interested in investing in cryptocurrency or bonds, for example, see whether they're offered.
- Investment research: If you value having your broker provide research for your investing, either on its own or from third-party sources, then check to see what resources a broker provides.
- Other financial services: It's becoming more common for brokerage companies to go beyond simple brokerage accounts to offer a wider range of financial services. For instance, many brokers let you open a bank account to hold cash, along with ATM access, debit cards, and even loans. If having all of your financial relationships with one company is important to you, then make sure the broker you choose offers a full suite of such services.
- Usability: Look into how easy it is to use each brokerage's online trading system and how user-friendly each website is.
- Convenience: Would you rather place trade orders through an actual person, your phone, or online? See which brokerages offer what you want. If you're looking to trade on the go, be sure to check out the Best Investment Apps.
- Customer service: Ask some questions of the customer service department to gauge its responsiveness.
Some of these factors are more important than others. For example, if you trade only twice a year, you don't need to seek out ultra-low commission costs. Make a list of all the features you need and how vital they are -- then evaluate each contender on the individual measures.
