Key Takeaways
- A brokerage account is a type of financial account that allows a person to trade investment products.
- Many different kinds of investment products can be held in an investment account, including stocks, bonds, mutual funds, and much more.
- Brokerage accounts offer fewer tax shelters than retirement accounts, but there are also fewer restrictions on when a trader can contribute or withdraw money.
Definition and Example of a Brokerage Account
A brokerage account is a type of taxable investment account that can be opened with a brokerage firm.The account holder can order trades, such as buying or selling stocks, and those orders are executed by the brokerage firm.
- Alternate name: Taxable account
Brokerage accounts are the more basic alternative to retirement investment accounts, like 401(k) plans and Roth IRAs. Unlike retirement accounts, which have special rules and tax advantages, brokerage accounts have very few restrictions, and any gains or losses (including dividends) are reflected on your taxes for that year.
How Does a Brokerage Account Work?
Brokerage accounts are easy to open. The process is similar to opening a checking account with a bank. Someone who wants a brokerage account files an application with a brokerage firm. The application will ask for basic personal information, such as your name, address, and Social Security number.
Once your application is approved, you deposit money into the account by writing a check, wiring money, or transferring money from your checking or savings account.After your deposited funds settle, you can use the money to buy different types of investment securities.
Note
In exchange for executing your buy and sell orders, you may pay the brokerage a commission fee. Fees vary by brokerage, so, before opening an account, shop around and pick a brokerage with a fee structure that works best for you.
There is no limit to the number of non-retirement brokerage accounts you are allowed to have.You can have as many or few brokerage accounts as you want, unless an institution chooses not to allow you to open a brokerage account. You can have multiple brokerage accounts at the same institution, segregating assets by investing strategy.You can have multiple brokerage accounts at different institutions, diversifying your relationships and exposure.
As you shop for a brokerage, take note of the financial strength of your broker and the extent of its SIPC coverage, which is the insurance that compensates investors if their stock brokerage firm goes bankrupt.Different types of assets have different levels of coverage, and some—like commodities—have no coverage at all.
What Can You Trade with a Brokerage Account?
You can trade more than a dozen types of investment products within a brokerage account. These investment products include but are not limited to:
- Common stocks and preferred stocks, which give investors partial ownership in a company
- Bonds, including U.S. Treasury securities, savings bonds, corporate bonds, tax-free municipal bonds, and agency bonds
- Mutual funds, such as index funds, which are pooled investment portfolios that combine funds from many investors to buy more shares than investors could buy on their own
- Exchange-traded funds (ETFs), which are a type of security that combines elements of both stocks and mutual funds
- Real estate investment trusts (REITs), such as hotel REITs, which are a type of ETF that deals with real estate investments
- Stock options and other derivatives
- Cryptocurrencies like Bitcoin
- Master limited partnerships (MLPs), which are complex partnerships with tax advantages (and potential tax consequences)
- Money markets and certificates of deposit (CDs), which are generally regarded as safer investments designed to protect cash while earning some income
Note
Some brokerage accounts will allow you to hold membership units in a limited liability company or limited partnership units in a limited partnership. These products are typically tied to investing in a hedge fund, so it may be difficult for new investors or less-wealthy individuals to access these options.
Types of Brokerage Accounts
While brokerage accounts have fewer special rules than retirement accounts, there are a few different kinds of brokerage accounts. When you're shopping for a brokerage account, pay attention to whether the account falls into one of the following categories.
Discount Brokerage
A discount brokerage account, or discount broker, is the most common form of brokerage account for casual investors who are just starting out. It may be an online-only brokerage, or there may be a few branch offices around the country.Everything is pretty much do-it-yourself, and you have to execute your own trades. As a result, you save on fees.
Full-Service Account
A full-service brokerage account is a brokerage account that pairs you with a dedicated broker who knows you, your family, and your financial situation.You can pick up the phone and speak to them, or walk into their office and regularly have meetings to discuss your portfolio.In exchange for that personalized service, you'll pay higher fees. These fees may be bundled into your commission fees, or they may be charged to your account in some other form.
Note
Some financial institutions offer both discount and full-service brokerage accounts.
Cash Brokerage Account
A cash brokerage account is one that requires you to deposit cash before you can start trading. In other words, the brokerage won't lend you any money, and you can't spend what you don't have. If you want to buy a stock worth $20, you have to deposit at least $20 into your account and use those funds to complete the trade. This limits traders to basic trades—they can't short a stock, for instance.
Cash accounts can be either discount or full-service accounts.
Margin Account
A margin account, as opposed to a cash account, allows you to borrow money to make trades. The broker essentially doubles as a lender, giving you what amounts to low-interest loans for the specific purpose of making trades. These loans allow for more advanced trades, such as shorting.
As with cash accounts, margin accounts can be either discount or full-service brokerage accounts.
While borrowing money to make trades enhances your potential gains, it also adds to your risk. Only experienced traders should consider using a margin account. Consider these factors:
- Margin brokerage accounts add more complexity to the way you collect dividends on your stocks.If things don't work out exactly right, you might not qualify for the lower dividend tax rates. Instead, you might be forced to pay ordinary tax rates, which can significantly increase your tax liability.
- Using margin can end in a financial disaster, no matter how confident you are in a trade. You can ultimately lose much more money than you initially invest, whereas, with a cash account, you can only lose the money you deposit into the account. A poor decision in a volatile market can land a trader in debt, and they'll be on the hook for contributing more money into their margin account just to settle that debt.
FAQs
A brokerage account is an investment account that allows you to buy and sell a variety of investments, such as stocks, bonds, mutual funds, and ETFs. Whether you're setting aside money for the future or saving up for a big purchase, you can use your funds whenever and however you want.
Is putting money in a brokerage account a good idea? ›
A brokerage account is a key part of your financial plan, as investing in markets is one of the best ways to achieve long-term growth. It's important that you work with a company or person you can trust, because it's your money and you are investing in your future.
What is the downside to a brokerage account? ›
Brokerage accounts don't offer all the services that a traditional bank offers. Brokerages might not offer additional products such as mortgages and other loans. Brokerages may not have weekend or evening hours.
What is an example of a brokerage account? ›
Popular kinds of cash brokerage accounts include: Retirement savings accounts: Investment accounts for retirement savings include tax-advantaged 401(k)s and IRAs with interest-gaining capabilities for long-term growth. Withdrawals are usually penalized until the account owner is at least 59 1/2, or there's a 10% fee.
How much money do you need to start a brokerage account? ›
Here are additional considerations for account holders to consider. Brokerage account minimums: Many brokers allow you to open an account with $1,000 or less. Some even allow you to open the account without making any deposit at all (though the account might be closed after a few months if you don't add funds).
Is a brokerage account like a bank account? ›
How Does a Brokerage Account Differ From a Bank Account? Brokerage accounts hold securities such as stocks, bonds, and mutual funds and some cash. A bank account only holds cash deposits.
Can you take money out of your brokerage account? ›
Yes, you can pull money out of a brokerage account with a bank account transfer, a wire transfer, or by requesting a check. You can only withdraw cash, so if you want to withdraw more than your cash balance, you'll need to sell investments first.
Is my money safe in a brokerage account? ›
SIPC provides up to $500,000 of protection for brokerage accounts held in each separate capacity (e.g., joint tenant or sole owner), with a limit of $250,000 for claims of uninvested cash balances. These limits do not mean that the account will only receive up to $500,000 of their invested securities.
Why should no one use brokerage accounts? ›
If the value of your investments drops too far, you might struggle to repay the money you owe the brokerage. Should your account be sent to collections, it could damage your credit score. You can avoid this risk by opening a cash account, which doesn't involve borrowing money.
Do you pay taxes on brokerage accounts? ›
Brokerage accounts are taxable accounts
The act of opening a brokerage account doesn't mean you'll be on the hook for additional taxes. However, investment income within a brokerage account — the profits from selling your investments — is subject to capital gains taxes.
Holding cash here is appropriate if you plan to spend the money within a few days or would like to quickly place a trade. Assets in your brokerage account are protected up to $500,000 per investor, including a maximum of $250,000 in cash by SIPC in the event a SIPC-member brokerage fails.
Can you lose cash in a brokerage account? ›
It is possible to lose money investing in securities. On the other hand, depositing your savings at an FDIC-insured bank ensures that your money is protected in the event of bank failure. Your deposits are automatically insured to at least $250,000 at each FDIC-insured bank.
Do millionaires use brokerage accounts? ›
Millionaires use brokerage accounts for low-cost index funds. “Buying and holding index funds in a brokerage account, it's possible to keep and grow wealth over the long term,” according to Business Insider.
What is better than a brokerage account? ›
IRAs are seen as long-term investment vehicles while a brokerage account allows for short-term investment opportunities and withdrawals.
How risky is a brokerage account? ›
Brokerage accounts are insured by SIPC up to $500,000 but the insurance doesn't cover the payback from your investments. It only covers missing assets if the broker goes down. If customer assets aren't missing, the SIPC insurance isn't needed.
Is it smart to have a brokerage account? ›
For example, if you want to buy a house with cash or save up a very large down payment, a brokerage account might be a good option if you plan to save for about five years. But for savings goals that will take less than five years, you might want to use a regular savings account or a money market account.
Is Roth IRA a brokerage account? ›
A Roth IRA is an account designed specifically for retirement and offers tax advantages when you invest in one. A brokerage account is a taxable investment account that gives you more flexibility than a Roth IRA.
How much do I need to invest to make $1000 a month? ›
A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.
How much money is needed to start a brokerage? ›
Depending on the type of brokerage you want to start (independent or franchise), your costs will run between $10,000 to $200,000. Which means in most cases, you'll need to drum up some funding to make your brokerage dreams a reality. SBA loans are used by a lot of new firms to get their brokerage off the ground.
How much money do I need to invest to make $3,000 a month? ›
Imagine you wish to amass $3000 monthly from your investments, amounting to $36,000 annually. If you park your funds in a savings account offering a 2% annual interest rate, you'd need to inject roughly $1.8 million into the account.
How to Withdraw Money from a Brokerage Account?
- Determine the Amount to Withdraw. ...
- Choose the Method of Withdrawal. ...
- Verify Account Information. ...
- Online Withdrawal. ...
- Phone Withdrawal. ...
- Check Withdrawal. ...
- Online Withdrawal Fees. ...
- Phone Withdrawal Fees.
There are no tax "penalties" for withdrawing money from an investment account. This is because investment accounts do not receive the same tax-sheltered treatment as retirement accounts like an IRA or a 403(b). There are also no age restrictions on when you can withdraw from your investment account.
Is it better to have a savings account or brokerage account? ›
If you are OK with possibly losing some of your cash in exchange for a good chance of earning a generous return on your investment, then a brokerage account is a better choice. If it's critical you have the money -- say, because it's for a down payment for a home you're buying soon -- choose a savings account.
How much money is safe to keep in a brokerage account? ›
Holding cash here is appropriate if you plan to spend the money within a few days or would like to quickly place a trade. Assets in your brokerage account are protected up to $500,000 per investor, including a maximum of $250,000 in cash by SIPC in the event a SIPC-member brokerage fails.
Is it better to invest in a 401k or brokerage account? ›
Brokerage accounts are taxable, but provide much greater liquidity and investment flexibility. 401(k) accounts offer significant tax advantages at the cost of tying up funds until retirement. Both types of accounts can be useful for helping you reach your ultimate financial goals, retirement or otherwise.
