What Is a Brokerage Account?
A brokerage account is an arrangement in which an investor deposits money with a licensed brokerage firm, which places trades on behalf of the customer.
Although the brokerage executes the orders, the assets belong to the investors, who typically must claim as taxable income any capital gains incurred from the account.
- Investors have different needs and should choose their brokerage firms accordingly.
- Investors who require a great deal of guidance and hand-holding may benefit from aligning with a full-service brokerage firm, which charges higher fees.
- Full-service firms charge either flat fees for their service, based on the size of the account, or commissions on the trades that they execute.
- Online brokerages charge lower fees and suit investors who wish to conduct their own trades.
Understanding Brokerage Accounts
There are multiple types of brokerage accounts and brokerage firms, giving investors the opportunity to cherry-pick the model that best suits their financial needs. Some full-service brokers provide extensive investment advice and charge exorbitantly high fees for such guidance.
On the other end of the compensation spectrum, most online brokers simply provide a secure interface through which investors can place trade orders, and they charge relatively low fees for this service. Brokerage accounts may also differ in terms of order execution speed, analytical tools, the scope of tradable assets, and the extent to which investors can trade on margin.
In any type of brokerage, the most basic kind of account is a cash account. This allows clients to buy shares using the money deposited in the account. You cannot, however, sell short, buy on margin, or trade options or other more sophisticated products. To do these things, you instead need a margin account. With a margin account, any deficit in cash will be loaned to you by your broker. The broker will charge you regular maintenance interest on this loan, and they may force you to add money if the account loses too much value, which is known as a margin call. If you cannot meet a margin call, your broker may be forced to sell securities in your account.
Types of Brokerage Accounts
Full-Service Brokerage Accounts
Investors seeking the expertise of a financial advisor should align with full-service brokerage firms such as Merrill, Morgan Stanley, Wells Fargo Advisors, and UBS. Financial advisors are paid to help their clients develop investment plans and execute the transactions accordingly. Financial advisors work on either a nondiscretionary basis, where clients must approve transactions, or a discretionary basis, which does not require client approval.
Full-service brokerage accounts charge either commissions on trades or advisor fees. A commission account generates a fee anytime an investment is bought or sold, whether the recommendation came from the client or the advisor, and whether the trade is profitable.
By contrast, advisor fee accounts charge flat annual fees, ranging from 0.5% to 2% on the total account balance. In exchange for this fee, no commissions are charged when investments are bought or sold. Investors should discuss compensation models with financial advisors at the onset of relationships.
Do-it-yourself traders should be careful about trading low-volume stocks, which may not have enough buyers on the other side of the trade, to unload positions.
Discount Brokerage Accounts
Investors who favor a do-it-yourself investment approach should strongly consider using discount brokerage firms, which impose significantly lower fees than their full-service brokerage firm counterparts. However, as the name suggests, discount brokerage firms such as Charles Schwab, TD Ameritrade, E*TRADE, Vanguard, and Fidelity offer fewer services in exchange for lower fees. This, though, may perfectly suit investors who mainly wish to execute low-cost investment trades via easy-to-use online trading software.
For example, an investor who signs up with a typical discount broker can expect to open a regular taxable brokerage account or retirement account at no cost, as long as they are able to fund the account with a $500 opening minimum. To buy or sell most stocks, options, or exchange-traded funds (ETFs), there is little or no commission. Some discount brokers may charge fees for non-U.S. stocks or thinly traded stocks, but this varies from one broker to the next.
Treasury bonds typically require no commission to trade, but secondary bonds may vary. Many brokers such as Schwab, Fidelity, and E*TRADE offer a wide variety of mutual funds for no transaction cost as well.123
Brokerage Accounts with a Regional Financial Advisor
Some investors prefer the personal interaction of a full-service broker but also want the benefit of a more personalized approach while working with a firm that feels more localized to the investor’s own community. Such investors typically consider using a medium ground between full-service brokerage firms and discount brokerage firms—companies such as Raymond James, Jefferies Group LLC, or Edward Jones. They act both as broker-dealers and financial advisors. This group requires a larger minimum account size and caters to individuals with a slightly higher net worth, but over time, their services tend to be less expensive than larger, full-size brokerages.
Online Brokerage Accounts and Downward Price Pressure
Launched in early 2015 under a mobile-only platform, online brokerage Robinhood offers commission-free trading and has no minimum account requirements, with the exception of its margin accounts. Although it bypasses commissions, the firm was a pioneer in being able to generate revenue from a practice known as payment for order flow (PFOF).4
Market-making firms that focus on matching buyers and sellers through electronic communication networks (ECNs) need a steady flow of orders from retail investors to match up with institutional buyers and sellers. Therefore, firms such as Citadel Securities or IMC find it useful to create an incentive for brokers to bring them orders. Paying brokers like Robinhood for the right to execute customer trades improved their speed and accuracy of execution and made Robinhood’s business model possible.
The amount paid by the market-making firm is far less than what typical equity trade commissions used to be (on a per-trade basis), so even if this cost ultimately gets passed on to the consumer in embedded fees, this model still benefits the consumer because of its reduced cost and its efficiency. In late 2019, almost all of the discount brokerage firms fully adopted this business model and switched to free commissions on most equity trades.
Zero-Commission Brokerage Accounts
In November 2017, Robinhood announced that it had surpassed three million brokerage accounts, exceeding $100 billion in transaction volume.5 Meanwhile, E*TRADE reported approximately 3.5 million brokerage accounts, with $311 billion in assets under management (AUM).6
There are drawbacks to zero-fee trading. Case in point: Robinhood does not offer investment advice that’s typically available from traditional brokerages. Robinhood likewise does not presently support annuities or retirement accounts.7 Firm officials say they may support the latter in the near future. But even so, Robinhood’s model proved to be so successful that in late 2019, the major discount brokers switched to a zero-commission model for most stock trades, demonstrating that customers prefer such an approach.
Cash Brokerage Accounts
A cash brokerage account requires you to deposit cash in order to start trading. This limits your options to the basics: for example, short-selling a stock is not possible within cash accounts. Cash accounts can be either discount or full-service accounts.
Margin Accounts
A margin account, as opposed to a cash account, allows you to borrow money to start trading. Therefore, the broker acts as a lender, and the borrowed funds allow for more advanced trades, such as short-selling a stock. Margin accounts can also be discount or full-service brokerage accounts. While a margin account offers you more flexibility when it comes to your options, there is some risk involved. If you are new to investing, it’s best to stick with a cash account at first.
Choosing the best brokerage account provider will depend upon a variety of factors: your investing style, your short and long terms goals, the types of investments you are seeking, and the level of service and support you want from your brokerage firm. A discount broker may be the perfect fit for more experienced investors who want to keep costs low, while a full-service broker may be the best option for those who need more advice and assistance when trading.
How to Open a Brokerage Account
Opening a brokerage account is a simple process that will take you just a few minutes. Before setting up your new account, consider your investing style and your goals. Are you an engaged investor who follows the markets daily? Do you take a more conservative approach? Are you investing for retirement?
Think of the associated costs too. Although most online brokers have no trading fees, you will still pay per-contract commissions on most options trades ranging from $0.10-$0.65 per contract at the majority of brokers. Once you have selected the brokerage account that best fits your needs, you can start the application process to open your account.
You will be required to provide some basic personal information, and once your profile is created and in order to start trading, you’ll need to put some cash into your account. Usually, you’ll have the option of a cash account or a margin account.
- Cash accounts are funded with cash that is transferred to the brokerage by linking your bank account to the brokerage account, mailing a check, or wiring funds.
- Margin accounts allow you to borrow money from the broker in order to trade and purchase securities, but bear in mind that you’ll pay interest.
Today, it is fairly quick and easy to open a brokerage account via the Internet. You will have to register and provide some required personal information such as your address, date of birth, and Social Security number. Account approvals today are quick, and the next step is to fund your new account, which also can be done online via Automated Clearing House (ACH) or wire transfer.
Is It Dangerous to Have a Margin Account?
Margin allows investors to do more things than with a cash account. These include selling short and buying on margin. These activities are inherently more risky than simply buying shares of stock, but they can also generate additional returns. Having a margin account is only dangerous if you become too overly leveraged in either direction. This is because a margin call caused by a severe event like a short squeeze can wipe out one’s account quite quickly.
Can I Have Multiple Brokerage Accounts?
Yes, although it may not be ideal to have your assets invested in several places where they may overlap or even contradict each other. You may choose to have one broker for long-term investing while opening a trading account for more speculative or short-term plays.
Which Brokerage Accounts Let Me Trade for Free?
Since Robinhood opened the doors to commission-free trading, dozens of online brokerage platforms have followed suit. These include major names such as Schwab, TD Ameritrade, E*TRADE, and Fidelity.
How Does a Brokerage Account Differ From a Bank Account?
Brokerage accounts are intend to hold securities such as stocks, bonds, and mutual funds. While a brokerage account can also hold cash, the purpose of such money is to be available to buy additional securities or to create a small cushion of liquidity.
A bank account, on the other hand, can only hold cash deposits. With a bank account, you can also often write checks or use a debit card. Today, some brokerage accounts also allow you to use a debit or check-writing facility.
Another difference is deposit insurance. Many bank accounts are Federal Deposit Insurance Corp. (FDIC)-insured for up to $250,000. Brokerage accounts are not insure in the same way, but they usually come with Securities Investor Protection Corp. (SIPC) protection, which can help recover some value of such accounts if a brokerage goes under.
The Conclusion
A brokerage account is a type of financial account that investors can open at a brokerage firm to trade investment products. They are a key part of an investor’s financial plan and an optimal way to achieve long-term growth.
Brokerage accounts are use to transact in a variety of investment products, including stocks, bonds, mutual funds, etc. They can also use by investors as a supplement to their retirement accounts like IRAs and 401ks, although they offer fewer tax shelters. However, there are also fewer restrictions on when a trader can contribute or withdraw money compared to retirement accounts.
