What Is a Brokerage Account? Definition, How to Choose, and Types

What Is a Brokerage Account?

A brokerage account is an investment account held at a licensed brokerage firm. An investor deposits funds into their brokerage account, and the brokerage firm transacts orders for investments such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs).

The assets in investment accounts belong to the investors, who must report any taxable income derived from the account.

Key Takeaways

• Investors have different financial and investment needs and should choose their brokerage firms accordingly.
• Investors who desire advisory services may benefit from a full-service brokerage firm, which charges higher fees.
• Full-service firms charge either a flat fee based on the account size or commissions on executed trades.
• Online brokerages charge lower fees and are suitable for investors who wish to conduct their own research and transactions.
• Robo-advisors offer financial planning, investing, and portfolio management using algorithms.

Understanding Brokerage Accounts

There are multiple types of brokerage accounts and firms, allowing investors to select the model that best suits their financial needs.

Full-service brokers provide extensive investment advice and other services, charging higher fees. Online brokers offer a secure interface for investors to place trade orders with lower fees. Robo-advisors use algorithms to provide financial planning and investment services at a low cost.

Brokerage accounts may differ in terms of order execution speed, analytical tools, tradable assets, and margin trading capabilities.

In any brokerage, the basic account is a cash account. This allows clients to buy investments using the money deposited in the account. For more advanced products and strategies, a margin account is necessary.

With a margin account, clients can get a loan from their brokerage for additional purchases, using their securities as collateral. However, this carries the risk of margin calls and potential sell-offs by the broker.

Types of Brokerage Accounts

Full-Service Brokerage Accounts

Investors seeking the expertise of a financial advisor can consider full-service brokerage firms such as Merrill, Morgan Stanley, Wells Fargo Advisors, and UBS. These firms provide investment advice, execute transactions, and monitor investments and markets.

Full-service brokerage accounts charge either commissions on trades or flat annual fees, depending on the compensation model agreed upon.

Discount Brokerage Accounts

Investors who prefer a do-it-yourself approach might consider discount brokerage firms like Charles Schwab, TD Ameritrade, E*TRADE, Vanguard, and Fidelity. These firms offer lower fees and easy-to-use trading platforms.

Discount brokers typically require a minimum account balance and charge little to no commissions on most stocks, options, and ETFs. They also provide a variety of no-transaction-cost mutual funds.

Robo-Advisor Accounts

Robo-advisors are digital platforms that use algorithms to provide financial planning and investment services. These accounts are suitable for both novice and experienced investors who prefer a hands-off approach to portfolio management.

Robo-advisors charge a fee based on the assets under management and have varying minimum account requirements.

Brokerage Accounts With a Regional Financial Advisor

Investors who prefer a personal relationship and a choice of services can consider regional brokerage firms like Raymond James, Janney Montgomery Scott, and Edward Jones. These firms act as broker-dealers and financial advisors, catering to individuals with a higher net worth.

While they may require a minimum account size, these regional firms tend to have lower costs compared to larger full-service brokerages.

Online Brokerage Accounts

Online brokerages are suitable for investors who prefer to select their own investments and execute trades independently. They offer research and analysis tools to assist investors in making informed decisions.

Online brokerages may charge per-transaction commissions or provide commission-free trading for certain securities. Some examples include Charles Schwab, Fidelity, E*TRADE, Vanguard, and TD Ameritrade.

Cash Brokerage Accounts

Cash brokerage accounts require cash deposits to start trading. These accounts are limited to basic transactions such as purchasing stocks. Short-selling, buying on margin, and trading options are not possible in cash accounts.

Margin Accounts

Margin accounts allow clients to borrow money from their brokerage for trading. The borrowed funds enable larger and more advanced trades. However, margin accounts carry the risk of margin calls and potential sell-offs by the broker.

Both cash and margin accounts can be either discount or full-service brokerage accounts. Investors new to trading are advised to start with a cash account.

To choose the best brokerage account, consider your investing style, goals, desired level of service and support, and the types of investments you seek.

How to Open a Brokerage Account

Opening a brokerage account is a simple process that only takes a few minutes. After choosing a firm and the type of account (taxable or tax-advantaged), gather the necessary personal information such as Social Security number, identification, employment details, and financial data.

The setup process involves questions about financial needs, investment goals, investing style, and risk tolerance.

Once the account is open, funding can be done online through Automated Clearing House (ACH) or wire transfer.

It is crucial to choose a brokerage that suits your needs before opening an account. Consider factors such as your engagement in investing, your approach to risk, and whether you have short-term or long-term goals.

Standard Brokerage Account vs. IRA Brokerage Account

Investors have the option to open both a standard brokerage account and an IRA brokerage account. Opening an IRA alongside a workplace retirement plan provides additional tax-advantaged savings opportunities.

A standard brokerage account is taxable, allows unlimited deposits, and offers flexibility in terms of investments and withdrawals. It is used for various purposes, such as long-term wealth-building and short-term financial goals.

A brokerage IRA account is tax-advantaged, subject to annual contribution limits, and offers tax benefits based on the type of IRA (traditional or Roth). Earnings grow tax-free in an IRA, and there are regulations regarding withdrawals.

The choice between a standard brokerage account and an IRA account depends on individual goals and financial situations.

How Can I Open a Brokerage Account?

Opening a brokerage account online is a quick and easy process. Register on the brokerage site and provide personal information such as address, date of birth, and Social Security number. Account approvals are fast, and funding can be done online through ACH or wire transfer.

Is It Dangerous to Have a Margin Account?

Margin accounts carry more risk than cash accounts because they involve borrowing money. Excessive borrowing and market downturns can result in a margin call, which may be difficult to meet. Brokers can sell securities in the account to recover the funds.

For beginners, it is best to start with a cash account and gradually move to a margin account once familiar with the risks.

Can I Have Multiple Brokerage Accounts?

Yes, investors can have multiple brokerage accounts. However, there are pros and cons to having assets invested in different places. Multiple accounts can be used at a single broker or for different investment purposes, such as long-term investing and short-term trading.

Which Brokerage Accounts Let Me Trade for Free?

Many online brokerage platforms offer commission-free trading, following the model introduced by Robinhood. Major brokers like Schwab, TD Ameritrade, E*TRADE, and Fidelity have also adopted this approach. Some fees may still apply, depending on the services and securities.

How Does a Brokerage Account Differ From a Bank Account?

A brokerage account holds securities and cash, allowing trading of stocks, bonds, and mutual funds. A bank account only holds cash deposits and offers check-writing and debit card features. While bank accounts are FDIC-insured, brokerage accounts have SIPC protection.

The Bottom Line

A brokerage account is a valuable tool for investors to buy, hold, and sell investment securities. It allows for a range of investments and offers different types of accounts to suit individual needs. Opening a brokerage account is a straightforward process, and investors can choose from various account types to meet their financial goals.