A Brokerage account is a kind of investment account for trading investments such as stocks, bonds, Exchange Traded Funds (ETF), and much more. It is usually owned, operated, and managed by an investor through a brokerage firm. While the brokerage firm places and manages the trading orders, the assets in the account belong to the owner.
Brokerage accounts are different from retirement investment accounts such as 401(k) and IRA. These accounts, 401(k) and IRA, are guided by specific rules and tax advantages but, in comparison, there are relatively lesser restrictions on a brokerage account.
How Do Brokerage Accounts Work?
Brokerage accounts operate in a similar way to normal bank accounts. You can contact your preferred brokerage firm to open a brokerage account. After fulfilling all account opening requirements, your account may be approved and you can deposit money for your trading into the account.
You can have as many brokerage accounts as you wish. You may decide to have multiple brokerage accounts with one brokerage firm or have multiple accounts in different brokerage firms. This can help you manage your assets in a better-structured way, and lets you explore different opportunities offered by different brokerage firms.
What Can You Do With a Brokerage Account?
You can use the money in your brokerage accounts to buy stocks, ETFs, mutual funds, and bonds as the case may be. Although your brokerage firm places trading orders on your behalf, you bear the losses and take the profits, whatever the outcome may be.
Also, you can save up your money in cash in your brokerage account, similar to what you do with your regular bank savings account. Brokerage firms may also offer you options on good returns from your uninvested money.
Brokerage Account Fees
There are several fees associated with brokerage accounts. These fees are applicable to your account and the amount charged differs due to the broker you subscribe to. It is advised that you find out the fees attached to your brokerage account ownership and operations prior to subscribing to a broker.
Some of the common brokerage account fees according to the United States Securities and Exchange Commission (SEC) include:
- Markups and Markdowns
- Wire or transfer fees
- Account Maintenance fees
- Inactivity fees
- Account closing fee
- Margin interest
- Investment advisory fees
- Annual operating expenses
Is My Money Safe in A Brokerage Account?
Besides the loss of brokerage investments by scammers, brokerage firms can fold, suspend or shut down due to certain reasons such as bankruptcy. This is why it is recommended to verify whether your brokerage firm is registered under the Securities Investor Protection Corporation (SIPC). If your broker is under the SIPC, you can rest assured your investment is insured even if the brokerage company shuts down.
The SIPC covers up to $500,000 worth of your assets and securities if your brokerage firm under them closes. However, there is a $250,000 cash limit on the SIPC coverage.
The SIPC protection covers most common assets such as bonds, mutual funds, and stocks. Note that the SIPC does not cover losses resulting from a reduction in the market value of your investments. Also, SIPC does not protect you from losses due to failed business decisions or poor investment and risk management.
Do I Need to Pay Taxes on My Brokerage Account?
Any income you generate from brokerage accounts is taxable. If you earn interest or dividends on the cash or stock in your brokerage account, you are expected to pay tax.
Also, you are expected to pay capital gains taxes when you make gains from selling your investments. You are required to pay the long-term tax rate in capital gains if you have owned the sold investment for more than one year. The short-term capital gains rate applies if you have been the owner of the investment for less than a year.
You are expected to pay tax on your brokerage account income in the same tax year you earned the income. Your tax payment does not depend on the time you withdraw your money.
How Much Money Do I Need to Open a Brokerage Account?
The acceptable minimum deposit for opening a brokerage account varies across different firms. There is no specific rule or general minimum requirement. Some brokerage firms may set $1000 as their opening balance while some others may set $2000 and above.
Some brokerage firms may offer a much lesser minimum opening balance on the condition that you will be making regular deposits, say monthly. There are even brokerage firms that do not require any minimum balance at all. Money is not a barrier to owning a brokerage account.
How Do I Open a Brokerage Account?
Opening a brokerage account is relatively easy as there are many options at your disposal. You can easily register with a broker online or find a professional financial advisor to guide you through the whole process.
Typically, a broker requests certain personal information from you before opening your brokerage account. Such information may include:
- Government-issued IDs such as passports, driver’s license, etc.
- Tax Identification Number or Social Security Number
- Employment status information
- Annual income
- Net worth
- Investment goals and objectives
One of the major factors to consider when opening a brokerage account is to choose your broker. Depending on your experience, investment goals, and other such factors, you may decide to go with an online brokerage account, Robo-advisors, or financial advisors/professionals.
Online Self-Directed Brokerage Account
If you are already an experienced investor, you can decide to monitor and manage your investments yourself. You can create an online brokerage account with an online broker and take the wheels from there.
This option offers little or no major assistance from algorithms and human professionals. You are totally in charge of your investments and the output. Also, online self-directed brokerage accounts are known to offer the lowest fees and commission.
Human Brokers and Financial Advisors
In a situation whereby you cannot manage your brokerage account by yourself, you can subscribe to the services of financial professionals. These are human brokers who are well experienced in financial investments.
Typically, when you choose a financial advisor, you get to meet and interact with the advisor or their representative. The essence is so they can understand your investment goals and align your investments to them. Your broker may also offer professional advice on other financial aspects of your life.
A Robo-advisor uses computer programs to create and manage your investments based on programmed algorithms. The Robo-advisor will require you to supply vital information about your investment such as your goals, risk level, timeline, and much more. With this information, the robo-advisor makes investment decisions for you.
This option is suitable for investors without any prior experience in investments. Also, it fits well for investors who may not have the time to manage and monitor their investments by themselves.
Types of Brokerage Accounts
There are various types of brokerage you can choose from, depending on your investment goals and other factors. Some of them include:
Full-Service Brokerage Accounts
Investors operating a full-service brokerage account are assigned to dedicated brokers who manage their investments. These investors have direct access to their account manager.
The broker assigned to you in this type of brokerage account gets to know you better, know what you want and your current financial state. This will enable them to figure out what exactly your investment seeks to achieve, and hence, choose the right investments for you.
Discount Brokerage Accounts
This type of brokerage account exposes you to very little or no interaction with your broker about your investments. Typically, you are fully in charge of your investment decisions and their corresponding outcomes.
Discount brokerage accounts are suitable for investors who can successfully manage their investments without requiring professional advice. Investors operating this type of account usually maintain small/medium portfolios and are charged relatively lower fees.
Cash Brokerage Accounts
Cash brokerage accounts require investors to deposit cash into their accounts before they can make transactions. This simply implies that you need to have at least the amount you want to transact with at each point in time.
In essence, your broker does not lend you any money. If you need to make an investment worth $400 for instance, you need to have at least $400 to be able to process anything. Cash brokerage can be operated with either a full service or discount brokerage account.
Margin Brokerage Account
Unlike cash brokerage accounts, a margin account lets you borrow money from your broker for your investments. The money you borrow attracts some interest as you make transactions with them.
Although margin accounts provide a useful way to gain capital, you have to be mindful of the risks associated with the borrowing. Miscalculated or failed transactions may eventually land you in debt if you’re unable to cover for them.
Brokerage Accounts vs Retirement Accounts
While both brokerage and retirement accounts are effective ways of investing for the future, there are differences between them. The most common differences are captured in their flexibility and tax system.
Brokerage accounts give more room for flexible transactions than retirement accounts. With a brokerage account, you can choose to deposit any amount of money you want without restrictions. You can also decide to trade any asset or security of your choice.
On the other hand, retirement plans such as 401(k) and IRA’s place certain restrictions on the transactions such as regular contributions, and withdrawal. Moreso, retirement accounts mostly offer a limited number of assets and securities you can invest in.
Another major difference is that income made from brokerage accounts is taxable. You will have to pay tax on every interest earned or every gain made in the sales of investments.
On the contrary, retirement account contributions are usually made before paying tax on the general income. You are not required to pay any tax on the balance in your retirement account. Additionally, withdrawals from retirement accounts do not also require tax.
With a well set up and managed brokerage account, you can secure your financial future with profitable investments. However, experience and expertise are very important if you must maximize the investment market. Hence, you may need the services of a financial advisor to guide your path into profitable investment decisions.