All You Need To Know About Brokerage Accounts.

A brokerage account is an arrangement in which an investor deposits funds with a licensed brokerage firm then executes trades on the investor’s behalf. Although the brokerage executes the orders, the assets belong to the investors, who must typically claim any capital gains incurred from the account as taxable income. If you’re still unfamiliar with brokerage accounts, let’s go deeper and learn more about them.

What is a brokerage account?

A brokerage account is used to buy and sell securities such as stocks, bonds, and mutual funds. A brokerage account can be opened at various licensed brokerage firms, ranging from full-service stockbrokers to low-fee online discount brokers.

You can transfer funds into and out of your brokerage account in the same way that you would a bank account, but unlike banks, brokerage accounts give you access to the stock market and other investments. Because investment income in a brokerage account is taxed as capital gains, brokerage accounts are also taxable accounts. This is in contrast to retirement accounts (such as IRAs), which have different tax and withdrawal rules and maybe better for retirement savings and investing.

A quick history of brokerages

Before the mid-twentieth century, access to the stock and bond markets was limited to the wealthy who had enough money to invest and could afford the services of a human broker to place trades and act as an investment advisor.

In the 1970s and 1980s, a slew of so-called discount brokerage firms sprang up, including Vanguard and Charles Schwab. Because their business models aimed to amass a large number of small clients, they were willing to accept a less affluent clientele.

The internet rose to prominence in the late 1990s and early 2000s, and online brokerages such as E*TRADE, FOREX.com, and Ameritrade (now TD Ameritrade, under Charles Schwab) thrived as they capitalized on the opportunity that new technology provided. They expanded the discount brokerage model by lowering commissions and requiring lower minimum balances. This was because they had far less overhead in physical space and human brokers placing trades, allowing them to pass these savings on to the consumer.

The rise of self-directed investing

The internet rose to prominence in the late 1990s and early 2000s, and online brokerages such as E*TRADE, FOREX.com, and Ameritrade (now TD Ameritrade, under Charles Schwab) thrived as they capitalized on the opportunity that new technology provided. They expanded the discount brokerage model by lowering commissions and requiring lower minimum balances.

This was because they had far less overhead in physical space and human brokers placing trades, allowing them to pass these savings on to the consumer. Betterment, arguably the first Robo-advisor, debuted in 2010 following the Great Recession. Since then, Robo-advising has seen exponential growth in adoption, with a flurry of startups and existing brokerages launching a Robo-advisor division. So, with all of these options, let’s see which type of brokerage is best suited for which type of investor.

Human brokers and financial advisors

Some people prefer to have their finances managed by a human. If this describes you, a traditional human advisor may better fit you than a Robo-advisor. Human brokers and financial advisors have been around since the dawn of modern stock markets, carving out a niche in today’s competitive landscape by catering to the more affluent investor (typically with $100,000 or more to invest) or those who prefer human interaction.

Influential financial advisors not only build and manage investment portfolios, but they also provide financial advice in all aspects of their clients’ lives and offer auxiliary services such as insurance, estate planning, accounting services, and lines of credit, either directly or through a referral network.

Customers of these brokers can expect to pay the advisor 1% or more of their assets under management per year or up to $50 per trade for individual transactions. Many advisors argue that these fees are well worth the added value they provide, whether it’s their ability to select stocks for their clients’ portfolios, access to unique products and offerings, or a comprehensive financial plan.

Many advisors are reachable by phone or email and are quick to respond. They also make it a point to meet with their clients in person when possible. When comparing this group of brokerages, keep independence in mind. Inquire whether your advisor is obligated to sell a specific product or service (for example, one offered by their company) or if they can provide you with the best products regardless of which fund family it came from.

Also, keep an eye out for fees. If they charge more than 1%, find out why and decide for yourself whether the extra cost is worthwhile. Professional certifications, such as the CFP or CFA designation, demonstrate that your broker has been trained and has passed a series of rigorous exams in financial markets and planning. Customers should use FINRA’s BrokerCheck tool to see if their broker has received regulatory complaints or has violated the FINRA Code of Ethics.

Online self-directed broker accounts

E*TRADE, TD Ameritrade, and Robinhood are among the many online self-directed platforms. Most financial institutions, including many banks, now provide their customers with self-directed online brokerage accounts. Citibank and Wells Fargo, for example, provide investing platforms. Now that we are 21 years into the twenty-first century, most of the discount brokerage space has consolidated into online investing.

For the most part, these platforms leave it up to you to determine which investments are the best. Still, they typically provide a suite of research and analysis tools, as well as expert recommendations and insights to assist you in making informed decisions. You will then be on your own to execute trades to build your portfolio via their website or mobile app.

These platforms charge a per-transaction commission, which typically ranges between $4.95 and $9.95 per stock trade, plus an additional $.50 to $1.00 per options contract. They allow you to trade on margin, develop options strategies, and invest directly in mutual funds, individual stocks, foreign exchange (forex), and exchange-traded funds (ETFs).

Online brokerages are ideal for self-directed investors who understand the markets or conduct their research to select the best portfolio for their objectives. If you only make a few trades per year, you may want to pay a little more per trade to gain access to higher-quality research and analysis. If you’re a day trader, you should look into a site that offers free trades to their most active users.

Each online brokerage has its own set of advantages and disadvantages. Who you are and what you value will guide you to the best one for you. Some people, for example, may value the convenience of having all of their financial accounts under one roof. Others may prefer interactive charts. Others, on the other hand, may value access to IPOs.

Human advisors charge higher fees than Robo-advisors or self-directed investing platforms, typically charging a per-transaction fee.

Robo-advisors

Robo-advisors use technology to manage your portfolio and automate investing. Since Betterment’s launch in 2010, there has been a surge in startups and established financial firms offering this algorithmic trading service.

Unlike the trading algorithms that power hedge funds and banks’ high-frequency trading (HFT) desks, Robo-advisors are more likely to invest your money in low-cost, indexed ETFs. Indeed, the convergence of ultra-low-fee ETFs and low-cost technology solutions available on mobile platforms enables Robo-advising.

Some platforms now allow you to invest with as little as $1 and pay as little as 0.15 percent in fees per year. Some venues do not charge any advisory fees, but they charge optional add-on services. Before Robo-advisors, you had to go online to a self-directed platform if you only had a few hundred or even a few thousand dollars to invest. You can now put your $200 or $2,000 to work without doing any investment research, selecting individual stocks, or worrying about rebalancing your portfolio.

Algorithm-based Robo-advisors seek to place you in a diversified and efficient passive portfolio. Many of these platforms will even tax-optimize your portfolios through tax-loss harvesting, which is the process of selling losing positions to offset capital gains generated by winning positions. The algorithms themselves are a Robo-proprietary advisor’s company secret.

Robo-advisors are an excellent choice for new or young investors with little capital to invest. Minimum balances for Robo-advisor accounts are pretty low, with some allowing you to begin with as little as $1. These platforms are also beneficial for those who prefer passive investment strategies, as your Robo-advisor will typically build a portfolio of indexed ETFs on your behalf.

Robo-advisors also excel for long-term investors who are simply too busy (or unmotivated) to conduct their research on which ETF has the best risk/return characteristics when combined with their associated fees, costs, and tax implications.

However, Robo-advisors are not for everyone. If you’re a regular trader, you might find them dull or unappealing. While Robos are adapting by allowing for greater portfolio customization (for example, most Robos will let you adjust your allocation weights away from their initial recommendation), it defeats the purpose of these products to begin speculating on hot stocks or volatile companies within these platforms. Similarly, if you are a sophisticated investor who requires margin, options trading, and technical charts, a Robo-advisor is not for you.

When selecting a Robo-advisor, cost, reputation, and additional services are the most important factors to consider. Keep an eye on the cost of extra benefits: some are free, but others have a fee.

Understanding different types of brokerage accounts

Various types of brokerage accounts and brokerage firms allow investors to select the model that best meets their financial needs. Some full-service brokers offer extensive investment advice and charge exorbitant fees for it.

On the other end of the compensation spectrum, most online brokers simply provide a secure interface through which investors can place trade orders, for which they charge relatively low fees. Brokerage accounts may also differ in the order of execution speed, analytical tools, asset scope, and the extent to which investors can trade on margin.

A cash account is the most basic type of account at any brokerage. This enables clients to purchase shares with funds deposited in their accounts. However, you cannot sell short, buy on margin, trade options, or other more complex products. Instead, you’ll need a margin account to do these things. Your broker will loan any cash deficit with a margin account that will be loaned to you by your broker. The broker will charge you regular maintenance interest on this loan, and if the account loses too much value, they may force you to add money, which is known as a margin call. If you fail to meet a margin requirement, your broker may be forced to sell securities in your account.

Full-service brokerage accounts

Investors looking for financial advice should work with full-service brokerage firms such as Merrill Lynch, Morgan Stanley, Wells Fargo Advisors, and UBS. Financial advisors are compensated for assisting their clients in developing investment plans and carrying them out. What is a brokerage account? This article provides a complete overview of a brokerage account and how you can open different kinds of brokerage accounts.    Financial advisors work on a non-discretionary basis, which requires clients to approve transactions, or a discretionary basis, which does not.

Full-service brokerage accounts either charge trade commissions or advisor fees. A commission account generates a price whenever an investment is bought or sold, regardless of whether the Discount Brokerage Accounts are used.

Investors who prefer a hands-on approach should strongly consider using discount brokerage firms, which charge significantly lower fees than full-service brokerage firms. As the name implies, discount brokerage firms provide fewer services in exchange for lower prices. Examples include Charles Schwab, TD Ameritrade, E*TRADE, Vanguard, and Fidelity. This, on the other hand, maybe ideal for investors who primarily want to execute low-cost investment trades through simple 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 can fund the account with a $500 minimum opening deposit. Most stocks, options, and exchange-traded funds (ETFs) have low or no commissions to buy or sell. Some discount brokers may charge fees for non-US stocks or infrequently traded stocks, but this varies from broker to broker.

Treasury bonds typically do not require a commission, but secondary bonds may differ. Many brokers, including Schwab, Fidelity, and E*TRADE, offer a wide range of mutual funds with no transaction fees.

Brokerage accounts with a regional financial advisor

Some investors prefer the personalized interaction of a full-service broker. Still, they also want the benefit of a more personalized approach while working with a firm that feels more localized to their community. Such investors typically consider using a brokerage firm that falls somewhere between full-service and discount, such as Raymond James, Jefferies Group LLC, or Edward Jones. They serve as both brokers and financial advisors. This group has a larger minimum account size and helps individuals with a slightly higher net worth. Still, their services tend to be less expensive over time than larger, full-service brokerages.

Online brokerage accounts and downward price pressure

Except for its margin accounts, online brokerage Robinhood, which launched in early 2015 as a mobile-only platform, offers commission-free trading and has no minimum account requirements. Even though it does not pay commissions, the company was a pioneer in generating revenue through a practice known as payment for order flow. Market-making firms that specialize in connecting buyers and sellers via electronic communication networks

(ECNs) rely on a steady flow of retail investor orders to match institutional buyers and sellers. As a result, firms like Citadel Securities and IMC find it beneficial to create an incentive for brokers to bring charges. Paying brokers like Robinhood for the right to execute customer trades increased their speed and accuracy, allowing Robinhood’s business model to be realized.

The amount paid by the market-making firm is far less than typical equity trade commissions (on a per-trade basis), so even if this cost is ultimately passed on to the consumer in embedded fees, this model still benefits the consumer due to its lower price and efficiency. By late 2019, almost all discount brokerage firms had fully embraced this business model and switched to no-commission trading on most equity trades.

Zero-commission brokerage accounts

In November 2017, Robinhood announced that it had surpassed 3 million brokerage accounts with a total transaction volume of more than $100 billion. In the meantime, E*TRADE reported 3.5 million brokerage accounts and $311 billion in assets under management (AUM).

There are some disadvantages to zero-fee trading. As an example, Robinhood does not provide investment advice, which is typically available through traditional brokerages. Robinhood currently does not support annuities or retirement accounts. Officials from the firm have stated that they may help the latter shortly. Nonetheless, Robinhood’s model was so successful that, in late 2019, the major discount brokers switched to a zero-commission model for most stock trades, demonstrating that customers prefer this approach.

How to open an online brokerage account

Step 1: choose the type of brokerage account you need

Consider your investing style when selecting a broker. Do you want to stay on top of the markets every day? Or are you the type of investor who prefers to set it and forget it? Consider the types of assets you’re comfortable trading or want to learn to trade if you’re staying involved in the markets. Most investors invest in stocks, exchange-traded funds (ETFs), and mutual funds. If you’re considering trading, there are several self-directed online brokers with various tools that can assist you in selecting appropriate strategies.

Many brokers allow you to invest in fixed-income securities online and provide bond screeners and other tools to assist you in developing a portfolio. Those who want to invest money but not time in building wealth should consider hiring a financial advisor or using a Robo-advisory service.

Robo-advisors will ask you a few questions about your time horizon and risk tolerance, as well as how much money you intend to invest. If you’re investing for retirement and the date is decades away, you may be more willing to invest in riskier asset classes than if you need to use your funds in three years.

You must also determine whether you want to open a regular taxable account or an individual retirement account (IRA). Another consideration is account ownership: are you opening an account solely for yourself, or will there be other owners (such as a spouse or a child) who can also log in? If you want to help a minor save for college, you can open a custodial account or a tax-advantaged tuition account, also known as a 529 Savings Account.

Step 2: consider the features you want and their associated costs.

The standard commissions for placing a stock trade receive much attention, but there is more to investing with an online broker than fees. Much of that debate died in the fourth quarter of 2019 when most online brokers eliminated equity trading fees and reduced commissions from per-leg options to zero. On most options trades, you’ll still have to pay per-contract commissions, with most brokers charging between $0.10 and $0.65 per contract.

Some “free” trades, though, come at a hidden cost. Research and news features are light (and sometimes non-existent), and you will likely get less-than-optimal fills for your transactions since the broker has to make money somewhere. Free trades are generally paid for by routing to market makers, who produce the broker for the order flow, but who do not prioritize price improvement.

Some “free” trades, on the other hand, have a hidden cost. Because the broker has to make money somewhere, research and news features are light (and sometimes non-existent), and you will likely get less-than-optimal fills for your transactions. Routing to market makers, who pay the broker for the order flow but do not prioritize price improvement, is how most free trades are paid for.

So, if you are new to investing, look for a broker with research and education features that can help you grow as an investor. This group’s members are recognized for their educational resources, ease of navigation, transparent commission and pricing structures, portfolio construction tools, and research resources.

Step 3: choose the brokerage that best fits your desired needs.

Don’t be afraid to use the Chat function provided by many brokers to ask their support representatives more in-depth questions. You may end up calling a new customer support line, which will allow you to assess the quality of the assistance provided. This is also an excellent time to read through the frequently asked questions (FAQs) on brokers’ websites to ensure you don’t encounter any surprises. When you’ve decided, click “Open an Account” to get started!

Step 4: Begin the application process

After you’ve settled on a broker, you still have to deal with the formality of opening an account.

No matter which firm or type of account you choose, there is some information you’ll need to have on hand before you start the account opening process.

You’ll need primary data about yourself and other account holders, such as social security number, date of birth, and address. Still, you’ll also be asked some questions about the nature of your employment. If you’re a U.S. resident but not a citizen, you’ll need to have your passport and residency visa handy.

Brokers are required to collect additional information to comply with a set of rules known as “Know your client,” intended to prevent money laundering and terrorist funding. To avoid being involved in identity theft, they must also ensure you are who you say you are.

Some of the questions may appear intrusive, but U.S.-registered brokers are required to ask them for the firm to create a profile of your investing experience and knowledge, ensuring that you invest in asset classes that you understand.

The regulations also govern the information that the broker can show you. Brokers are only permitted to provide limited types of advice to self-directed investors, so the questions they ask to assist them in categorizing you.

You’ll be asked how you feel about taking financial risks, as well as how long you plan to keep the investments. This profile includes your tax status (single, married, filing jointly, etc.), as well as any other assets you own, such as a house, a checking account, or an employer-sponsored retirement account. You will also be asked for a range of your annual income. Don’t worry about whether your answers are correct to the penny or percent.

Brokers are not required to verify or update this information during your relationship. Still, if your circumstances change, you can always return to the site’s profile section and update your responses, especially if you want to access additional asset classes.

If you are hesitant to provide this information online, you can download and print a paper application, which you will need to fill out and mail back, but this will delay the establishment of your account by at least a week. You could also walk into a branch of one of the brokers with a physical location and open an account in person. However, the websites set up by brokers have a great deal of security built-in, and they also provide the fastest way of opening and funding an account.

Step 5: fund your new account and start investing.

After you’ve created your account, you’ll be able to develop your online credentials (user ID and password) for logging in.

To begin trading, you’ll need to deposit funds into your account. You have a few options here, but by far, the simplest is to link a bank account to your brokerage account. You’ll need your bank’s nine-digit routing number as well as your account number, which is typically ten digits long. The routing number can be found on a check, on your bank’s website, or by the American Bankers Association’s routing number lookup.

You can also write a check and mail it, but this will cause your account to be opened a week or so later. The benefit of linking a bank account to your brokerage account is the ease with which money can be transferred back and forth. By law, you cannot fund a brokerage account with a credit card with a broker based in the United States.

Some brokers also allow you to schedule a monthly transfer of funds from your checking account to your brokerage account. This is especially useful for funding a retirement account or saving for a specific goal. Making regular deposits is a great way to put technology to use.

Depending on how you deposit money, there will be a delay of one to seven days between the opening of your account and when you can begin trading. Take advantage of this time to familiarize yourself with the broker’s website and mobile apps by watching introductory videos and organizing your home page. Create a stock watchlist and experiment with the broker’s stock and fund scanners.

Most brokers now charge a small monthly fee of $1-2 to send paper statements and confirmations, but you can avoid those fees by opting into electronic notifications. You should also edit your profile to specify which types of emails and snail mail you want to receive from your broker and their partners. Once your deposit has made it into your new account, you can start to place some trades.

Is it difficult to open a brokerage account?

It has never been easier, especially online, to open and fund a new brokerage account. Because of digital signatures, e-verification, automated risk profiling, and electronic funding options, you can apply for and be approved in minutes to hours – and have your account funded within 24 to 48 hours.

Should I open a brokerage account online?

Sure, if you’re comfortable using an online brokerage platform. Every primary service provider provides an easy-to-use and secure onboarding process. If you prefer to speak with or meet with a broker in person, you can do so by visiting a branch office of a discount or full-service broker.

How can I open a brokerage account?

It is now relatively quick and straightforward to open a brokerage account via the Internet. You must register and provide personal information, such as your address, date of birth, and Social Security number. Account approvals are now quick, and the next step is to fund your new account, which can also be done online via ACH or wire transfer.

Is it dangerous to have a margin account?

Margin enables investors to do more than they could with a cash account. Selling short and buying on margin are two examples. These activities are inherently riskier than simply purchasing stock shares, but they can also generate additional returns. Having a margin account is tricky if you become too leveraged in either direction. This is because a margin call caused by a severe event, such as a short squeeze, can quickly wipe out one’s account.

Can I have multiple brokerage accounts?

Yes, but it may not be ideal to have your assets invested in multiple locations where they may overlap or contradict each other. You may want to use one broker for long-term financing and another for more speculative or short-term trades.

Which brokerage accounts let me trade for free?

Since Robinhood made commission-free trading available, dozens of online brokerage platforms have followed suit. Names like Schwab, TD Ameritrade, E*TRADE, and Fidelity are.

How does a brokerage account differ from a bank account?

Securities such as stocks, bonds, and mutual funds can be held in brokerage accounts. While cash can be stored in a brokerage account, the purpose of such funds is to be available to buy additional securities or to create a small cushion of liquidity.

In contrast, a bank account can only hold cash deposits. You can also use a bank account to write checks or use a debit card. Some brokerage accounts now include using a debit or check-writing facility.

Another distinction is deposit insurance. Many bank accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. Brokerage accounts are not guaranteed in the same way, but they typically include Securities Investor Protection Corp. (SIPC) protection, which can help recover some of the value of such accounts if a brokerage fails.

Whether the recommendation came from the client or the advisor, as well as whether the trade is profitable, on the other hand, Advisor fee accounts charge flat annual fees ranging from 0.5 percent to 2 percent of the total account balance. No commissions are charged when investments are bought or sold in exchange for this fee. Investors should discuss compensation models with financial advisors from the beginning of their relationships.

Conclusion

Now that you have gone through this article, you must be familiar with brokerage accounts and their various types. Now more than ever, it is easy to open a brokerage account. With so many options out there and the ease of opening an account online, you must choose wisely the specific account that might benefit and suit your needs. First, decide the type of broker you need, along with the features they offer and at what cost. After narrowing your selection, choose the one you feel best about. After you finish the application process, fund your account and begin trading.