A brokerage account is a taxable account that allows individual investors to buy and sell a wide range of investment securities, including stocks, bonds, ETFs, and mutual funds.
Brokerage Account Definition and Example
A brokerage account is a deposit or taxable investment account available through a brokerage firm. The account holder can place trades, such as buying or selling stocks, and the brokerage firm will execute those orders. Account taxable is an alternative name. Brokerage accounts are a simpler alternative to retirement investment accounts such as 401(k) plans and Roth IRAs. Unlike retirement accounts with unique rules and tax benefits, brokerage accounts have few restrictions. Any gains or losses (including dividends) are reflected on your tax return for that year.What Is the Function of a Brokerage Account?
Brokerage accounts are simple to set up. The procedure is similar to that of opening a bank account. A person who wishes to open a brokerage account applies to a brokerage firm. The application will request basic personal information such as your name, address, and Social Security number. When your application is approved, you deposit funds into your account by writing a check, wiring, or transferring funds from your checking or savings account. After your funds have settled, you can use them to purchase various types of investment securities.Warning:
The brokerage may charge you a commission for executing your buy and sell orders. Fees vary by brokerage, so shop around before opening an account to find one with the best fee structure for you. There is no restriction on the number of non-retirement brokerage accounts you may have. Unless an institution refuses to allow you to open a brokerage account, you can have as many or as few as you want. You can have multiple brokerage accounts at the same institution, each with a different investment strategy. You can have multiple brokerage accounts at different institutions, allowing you to diversify your relationships and exposure. SIPC coverage is insurance that compensates investors if their stock brokerage firm goes bankrupt. Different assets have varying levels of coverage, and some, such as commodities, have no coverage. Please take note of your broker's financial strength and the extent of its SIPC coverage as you shop for a brokerage.What Can a Brokerage Account Be Used For?
A brokerage account allows you to trade more than a dozen investment products. 3 Among these investment products are, but are not limited to:- Common and preferred stocks give investors a stake in a company.
- Bonds include US Treasury securities, savings, corporate, tax-free municipal, and agency bonds.
- Mutual funds, such as index funds, are pooled investment portfolios that pool funds from multiple investors to purchase more shares than individual investors could buy on their own.
- Exchange-traded ETFs are a type of security that combines elements of both stocks and mutual funds.
- Real estate investment trusts (REITs), such as hotel REITs, are a type of ETF that invests in real estate.
- Options on stocks and other derivatives
- Bitcoin and other cryptocurrencies
- MLPs (master limited partnerships) are complex partnerships with tax advantages (and potential tax consequences)
- Money markets and certificates of deposit (CDs) are generally considered safer investments intended to protect cash while earning income.
Note:
Some brokerage accounts will allow you to hold limited partnership or membership units in a limited liability company. Because these products are typically linked to investing in a hedge fund, they may be difficult to access for new investors or those with less wealth.Brokerage Account Types
While brokerage accounts have fewer special rules than retirement accounts, they are divided into several types. When looking for a brokerage account, consider whether it falls into one of the following categories.Brokerage at a Discount
A discount brokerage account, also known as a discount broker, is the most common type of brokerage account for inexperienced investors. It could be an online-only brokerage, or it could have a few branch offices across the country. Everything is primarily do-it-yourself, and you must carry out your trades. You save money as a result.An account with Full Service
A full-service brokerage account matches you with a dedicated broker familiar with you, your family, and your financial situation. You can call them or go to their office to meet regularly to discuss your portfolio. We will charge higher fees in exchange for that personalized service. These fees may be included in your commission or separately charged to your account.Note:
Some financial institutions provide both discount brokerage accounts and full-service brokerage accounts.Account for Cash Brokerage
A cash brokerage account requires a cash deposit before you can begin trading. In other words, the brokerage will not lend you money, and you cannot spend money you do not have. To buy a $20 stock, you must deposit at least $20 into your account and use those funds to complete the transaction. These hold back traders from basic trades—they can't, for example, short a stock. Cash accounts come in two varieties: discount and full-service.Account for Margin
In contrast to a cash account, a margin account allows you to borrow money to make trades. The broker essentially acts as a lender, providing you with low-interest loans to make trades. 4 These loans enable more sophisticated trades, such as shorting. Margin accounts, like cash accounts, can be discount or full-service brokerage accounts. While borrowing money to make trades increases your potential profits, it also increases your risk. Experienced traders should only use a margin account. 5 Consider the following factors: Margin brokerage accounts complicate the way you receive dividends on your stocks. If things don't go exactly as planned, you might be unable to take advantage of the lower dividend tax rates. Instead, you may be required to pay regular tax rates, which can significantly increase your tax liability. No matter how confident you are in a trade, using margin can lead to financial disaster. You could lose much more money than you initially invested, whereas, with a cash account, you can only lose the money you deposit. A wrong decision in a volatile market can put a trader in debt, and they'll have to put more money into their margin account to pay off that debt.Important Takeaways
- A brokerage account is a financial account that allows you to trade investment products.
- An investment account can hold many investment products, including stocks, bonds, mutual funds, etc.
- Brokerage accounts provide fewer tax benefits than retirement accounts but have fewer restrictions on when a trader can contribute or withdraw funds.
