What Is a Brokerage Account and How Does It Work?
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If you want to buy and sell stocks, mutual funds, and ETFs and build wealth through the stock market, you'll want to open a brokerage account. 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.
In this guide, we'll answer "what is a brokerage account" and cover exactly how a brokerage account works.
A brokerage account is an investment account that lets you buy and sell different types of investment assets. Most popular brokerage companies offer accounts that let you invest in stocks, bonds, and exchange-traded funds. Some brokers let you create a portfolio in other financial markets, such as foreign exchange, commodities, options, and even newer asset classes like cryptocurrencies.
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.
Brokerage accounts fall into two broad categories: online and full service.
Discount brokerage accounts 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.
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.
Learn more: Full service vs. discount broker
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Not sure where to start? Consider opening an account with a beginner-friendly broker. You can typically do so at zero cost. Do your research and start small -- you'll learn more from losing money to the market than you will reading whole books on investing.
In addition to the various types of brokerages, there are several different options among brokerage accounts. Here's how some of those accounts differ:
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.
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.
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?
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.
There are many different types of orders you can use in your brokerage account that will get you the results you want:
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:
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.
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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.
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.
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