How Does a Brokerage Account Work

There are dozens of companies that offer brokerage accounts. Many of them even offer lucrative rewards to open an account. But amid all the advertising and promotional material from these companies, it's easy to lose sight of exactly how a brokerage account works and why you should have one.

The basics of a brokerage account

A brokerage account lets you buy and sell different types of investments. Most popular brokerage companies offer accounts that let you trade stocks, bonds, and exchange-traded funds. Some brokers add the ability to participate in other financial markets, such as foreign exchange, commodities, options, and even cutting-edge asset classes like cryptocurrencies.

Full-service brokerage vs. online brokerage

Brokerage accounts come in two broad categories: full-service and online. We'll explore the pros and cons of each below.

Full-service

Those who want to have a close personal connection with a financial advisor at their chosen brokerage company might prefer a full-service brokerage account. This usually includes the opportunity to consult with in-house experts to help you choose investments, do bigger-picture financial planning, manage taxes on investments, or just get a gut-check when an unexpected market downturn makes you nervous.

The downside of full-service brokerage accounts is that they typically require expensive fees along the way. Some charge hefty commissions, while others collect a percentage of your assets at regular intervals.

Online

Online brokerage accounts, on the other hand, are more of a self-service option for investors. The fees on these accounts are generally extremely low. This is largely because in making choices about your investments, you're more or less on your own with an online broker.

Some discount brokers offer access to advisors or investment research, but you shouldn't expect the same level of commitment a full-service broker provides, because you're not paying as much with a discount brokerage account.

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.

Are brokerage accounts safe?

Brokerage accounts are generally as safe as the investments you hold in them. If you make a bad investment that loses value, there's no protection that will get your money back.

However, most brokers do offer protection against problems involving the company itself. The Securities Investor Protection Corporation offers up to $500,000 in protection per account, including a $250,000 cash limit. If your brokerage firm fails, the SIPC works to replace your missing investments up to those limits. Again, though, the SIPC provides no protection if your losses are due to your investments falling in value.

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.
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.
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.

Find the right fit

The most important consideration in finding a brokerage account is whether you'll be able to do everything you want with your investments in a way that's comfortable to you. The best brokers offer the support their customers need without being pushy about it, at a price that's right. Fortunately, with so many financial providers offering brokerage accounts right now, you have a very good chance of finding the perfect fit between what a broker has to offer and the needs you have in reaching your financial and investing goals.

How Does a Brokerage Account Work?