by The Ascent Staff | Dec. 2, 2018
If you want to buy and sell stocks, mutual funds, and ETFs and build wealth through the stock market, you'll want to open an account at a brokerage firm. There are various types of brokerage accounts -- online or at brick-and-mortar locations, full-service or discount, and many with financial advisers available, too.
Here's a comprehensive answer to the "what is a brokerage account" question, along with guidance on how to choose and use a brokerage account.
A brokerage can be defined in various ways: It's a company that connects buyers and sellers; a business that acts as a middleman, facilitating transactions; and/or an enterprise that buys and sells various assets for its clients. When it comes to the stock market, brokerage accounts exist to help investors buy and sell securities.
A brokerage account allows an individual investor, who has deposited money with a licensed brokerage firm, to make orders to buy and sell assets with the firm serving as their representative for the transactions. Depending on the brokerage, you can create an account online, over the phone, or in person. Once you have an account, you then need to fund it with money in order to buy and sell stocks, mutual funds, or other securities. There's more to it than that, of course, so let's take a closer look.
If you're not yet sold on the need for a brokerage account, check out the table below, which shows how much money you could potentially amass by investing in the stock market for various lengths of time. The long-term average annual return for the stock market has been close to 10% over long periods, but there's no telling exactly how it will perform over the specific period that you invest, so a more conservative 8% rate is used.
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Clearly, if you sock away some significant sums each year and invest them effectively, you can accumulate some powerful sums. If you can grow a nest egg of $500,000 over 20 years, for example, that would be enough to generate about $20,000 in your first year of retirement, if you use the 4% rule when you withdraw funds.
|25 years||$394,772||$789,544||$1.2 million|
|30 years||$611,729||$1.2 million||$1.8 million|
Calculations by author.
There are different kinds of brokerages to choose from. Some, for example, exist solely or mainly online, which is where you conduct much or all of your business with them. Others have branches all over the country, allowing you to walk in and talk to a customer service agent face-to-face. Most of these brokerages with branch networks also offer online access to your accounts and the ability to trade online, as well.
These are the three main categories brokerages fall into:
In addition to the various types of brokerages, there are several different options among brokerage accounts. Here's how some of those accounts differ:
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.
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When you're ready to open an account, choose your brokerage firm carefully, it's important to select one that best suits your needs. Here are some considerations -- you can decide which are the most important to you:
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.
When you trade securities in your brokerage account, you'll be placing orders. The main orders you can place with your brokerage firm to buy or sell stocks are listed below. Note that some can be combined.
Just as our government insures our bank accounts through the Federal Deposit Insurance Corporation (FDIC), it also protects our brokerage accounts through the Securities Investors Protection Corporation (SIPC). Understand, though, that you're not protected from losses due to regrettable investing decisions, such as investing in a stock that plunged. Instead, you're protected from the failure of your brokerage. When selecting a brokerage, be sure that it's a member of the SIPC.
There can be danger with a brokerage account if you use your brokerage firm's handy smartphone app that lets you check your account balances and place trades, among other things. As with banking apps and other financial apps, the convenience is wonderful, but be careful using any apps tied to financial accounts. You don't want your precious financial accounts hacked or tampered with. If you're out and about, be sure to connect through a secure network, not an open Wi-Fi system.
Finally, if you're ever unhappy with your brokerage or just want to do business with another company instead, you can always transfer your account (and all of its holdings) to a different brokerage. It's not an enormous hassle, and the new brokerage will be happy to do much of the work for you. Just contact it or find the relevant forms on its website. You won't have to sell all your holdings and your cost bases won't change, either. Some brokerages charge modest account-transfer fees, while others absorb all costs in order to get you in the door.
For many people, a brokerage account is more than just a fun or handy thing to have -- it can be a tool that helps you build a comfortable financial future.
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