What Is a Brokerage Account and How Does It Work?

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You’ve probably heard of investors talking about their brokers, but maybe you were too afraid to ask: what exactly is a broker? What about a brokerage account?

We’re here to explain it. A brokerage account is sort of like a bank account: it’s an account held with a financial institution that you put in charge of your money. However, unlike a bank account, a brokerage doesn’t just hold your money; they invest it for you, helping you to grow it. 

In this post, we’re explaining everything you need to know about brokerage accounts: how they work, the different kinds available to you, and the benefits and risks associated with brokerage accounts. Read on to find out what you should have in mind as you seek out the best investment options for your portfolio. 

Let’s kick it off with a straightforward brokerage account definition. 

What is a brokerage account?

A brokerage account is an investment account. It’s an account held with an investment company or brokerage firm where you can manage, organize, and pursue different investment portfolios. Often, selecting the right portfolio for your particular goals is a service offered by the brokerage.

A human broker or automated questionnaire may ask you about your ambitions, how long you plan on investing (your time horizon), and your risk tolerance (the amount of risk you’re willing to take to earn money). Then, your broker will invest in a set of stocks, bonds, commodities, or other options in line with your investment preferences. They may also help you decide how to rank your investments and priorities moving forward, too.

While it’s good to know how to invest on your own, it’s also smart to know when to seek guidance — brokerage accounts provide you with that guidance. 

How does a brokerage account work?

Opening a brokerage account is often as simple as opening a checking or savings account. Once you find the right brokerage firm that you want to work with, you can usually sign up online or at a storefront location by providing personal information and, sometimes, paying a fee to open your account. 

Once your account is opened, you can provide the brokerage firm with information about your method of funding the account. For instance, you may wish to set up a direct deposit from a checking account into your investment account, and provide information on where withdrawals from your brokerage account will be deposited. Or you may simply wish to write checks to your brokerage when you wish to make another investment. 

After you’ve decided on your investment preferences and strategy, and funded your investment account, your broker will purchase the shares that are in line with your goals. Some brokerage accounts allow you to directly select the shares or funds you wish to purchase from; every brokerage account is different, and you should research what different accounts offer before opening one. 

There are also two more important things about how brokerage accounts work that you should keep in mind:

  • Brokerage accounts are taxable. Any money you make through investments is subject to capital gains taxes, both federally and potentially in the state you live in. This differs from retirement accounts, like 401ks and IRAs, which are tax advantaged; you may get a deduction or exemption for money earned through those retirement vehicles.

  • You can have as many brokerage accounts as you like. There’s no limit to the number of brokerage accounts you would like to have open. Some investors like to diversify their investments and investment strategies by having multiple accounts that serve different purposes. For instance, you may want to have one account that focuses on lower risk options like ETFs and index funds, and a separate investment account for taking bets on individual stocks. Bear in mind, however, that this may complicate your tax situation. 

Another question many people have is, “what do brokerage accounts allow you to purchase?” The answer is, depending on the account, pretty much any financial product. That includes:

  • Stocks
  • Bonds
  • Dividend stocks
  • Exchange traded funds (ETFs)
  • Mutual funds
  • Cryptocurrency 
  • Real estate and REITs

There are potentially more options too, depending on your brokerage. Be sure to research what options you have when determining what brokerage service is right for you. 

Types of brokerage accounts

Different investors have different preferences when it comes to their strategies and desired level of involvement with their investment accounts. There are tons of different kinds of brokerages, from full service accounts managed by an individual broker, to trendy and tech savvy online robo advisors. 

These are a few important distinctions to keep in mind as you shop around for the right account. 

Online, automated, and full service brokerage accounts

These days, brokerage services come in a variety of different forms to suit different investors’ preferences. You might want to have a very hands on approach to your account; or, you might want to open it up and forget about it while it slowly grows in value. 

One of the easiest, least expensive options for those just getting started investing is to open an automated online brokerage account, often called robo advisors. A robo advisor account is very similar to an online checking account: you open it up, select your funding options, and then fill out a questionnaire letting the service know how you want to invest. 

The clever algorithms will then select an optimized portfolio built to suit your preferences, and it simply earns value in the background, making it a great option for novice investors. In fact, robo advisors are rapidly growing: Charles Shwab estimates that, in 2021, 17 million Americans will be using robo advisors. 

A full service brokerage, on the other end of the spectrum, is operated by a human broker who selects the stocks, bonds, and funds that work best for you. With a full service broker, you’ll have the ability to ask questions, discuss options, plan strategies, and make specific changes more easily (for example, if you want to divest from a particular company whose ethics you don’t agree with). These services are usually more expensive.

There is a spectrum of different options between those two mentioned above, with plenty of firms offering a hybrid of automated and human brokerage services that allow you to work with a financial planner while algorithms help to plan your strategy. 

Cash vs margin brokerage accounts

There are also two different ways that your brokerage account can handle funding your purchases: cash and margin. Here’s what you need to know:

  • Cash: Cash accounts use cash or long positions (a type of stock holding) to fund transactions. This means that the investor (you) must deposit cash or sell holdings for cash in order to fund the purchases of new holdings. This is a straightforward and common way for brokerages to purchase stocks for their clients.
  • Margin: Margin accounts allow investors to borrow money in order to purchase new holdings. Investors borrow against the value of currently held assets in order to fund the purchase of new ones. Under certain circumstances, investors may be required to pay cash or sell holdings for cash in order to make up for securities that depreciated. The limit for this is decided by your broker based on the total amount of debt investors are allowed to maintain. 

What is a brokerage fee?

As the old saying goes, you have to spend money to make money. Brokerage accounts are no different. Different brokerage firms charge different fees for the varied services they may offer. Some firms, particularly online automated brokerages, offer low to no fees for certain amounts managed. For instance, a robo advisor may allow you to invest $1000 before they start charging fees. 

A full service brokerage that allows investors to schedule calls and meetings with brokers, alternatively, may be more expensive. A good rule of thumb is that, the more customer service options available, the higher the fees may be. 

Unless your stocks significantly depreciate, however, in many cases the price of the fees is worth the money to be made from your investments. The important thing to decide is what level of service you’re willing to pay for. 

Brokerage account benefits & risks

It’s good to remember that all financial moves come with both risks and benefits. Brokerage accounts are no different. Here’s what you should keep in mind:

  • Benefits
  • Brokerage accounts allow you to purchase financial products like stocks, bonds, and funds.
      • They are a convenient way to increase your passive income through diverse investments. 
      • Brokerage accounts help you invest without having to dive in on your own.
  • Risks
    • Not all brokerage services are equal. Some may have better reputations than others; be sure to research this ahead of time. 
    • All investing is inherently risky. Even if purchased through a broker, your investments may depreciate, causing you to lose value. 
    • Some brokers can charge high fees, decreasing the total amount of money you earn from your holdings.

How do I open a brokerage account?

Opening a brokerage account is simple. Here’s what you need to do:

  1. Research your options, and find the brokerage service that works best for your goals. 
  2. Put together necessary personal information, like an email, phone number, social security number, and financial account information, like a checking account number and routing number. 
  3. Sign up online (it’s usually as simple as opening a new bank account) or by walking into a location and speaking with a representative. 
  4. Select the portfolio options that work best for you, like your risk tolerance, time horizon, and goals. 

After that, you’re ready to start investing. If this is your first time, you won’t want to miss our guide to investment mistakes it’s smart to avoid.

Brokerage account takeaways

Here’s what to remember:

  • Brokerage account definition: Brokerage accounts allow investors to work with professionals who help develop investing strategies and decide how to allocate funds. 
  • You can open a brokerage account with many different services online. 
  • Brokerage accounts can be inexpensive or have relatively high fees depending on the level of customer service you desire. 
  • They can also be cash accounts (using liquid cash to fund transactions) or margin accounts (borrowing money against held assets to fund purchases). 
  • As with all investments, there are risks and benefits associated with brokerage accounts, like the possibility that you will earn money, or that your investments may depreciate. 

The good news is that many brokerage services allow you to connect your accounts directly to the Mint app. That makes it easy to keep track of your investments, bank accounts, debts, and total net worth all in one place. You can also use our investment calculator to help you plan ahead.

Once you’ve found the brokerage account that’s right for you, connect to the Mint app and get started managing your money. 

Sources:

FINRA.org | SEC.gov | Investor.gov | Charles Schwab

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