If you’re looking to get started investing, you may be wondering what a brokerage account is and whether or not you need to set one up. A brokerage account is a type of investment account typically opened with a brokerage firm.
Keep in mind that there are a few different types of brokerage firms. While all offer brokerage accounts, they usually come with different fees and services:
• A full-service brokerage firm usually provides a variety of financial services, including allowing you to trade securities. Full-service firms will sometimes provide financial advice and automated investing to customers.
• A discount brokerage firm doesn’t usually provide any additional financial consulting or planning services. Thanks to their pared down services, a discount brokerage firm often offers lower fees than a full-service firm.
• Online brokerage firms provide brokerage accounts via the internet, although some also have brick and mortar locations. Online brokers often offer the lowest fees and give investors freedom to trade online with ease. They also tend to make information and research available to consumers.
How Does a Brokerage Account Work?
Opening a brokerage account starts out as a similar experience to opening any other type of cash account. Consumers can simply start an account either online or in person.
Some brokerage firms require investors to use cash to open their accounts and to have enough funding in their account to cover the cost of stocks or bonds as well as any commission fees. There are some however, like SoFi, that don’t require any initial deposit.
In order to make their first investment however, consumers need to deposit money. They can do this by moving money from another account, such as from their checking or savings accounts. From then on, the brokerage firm can help individuals execute buy or sell orders on stocks, exchange-traded funds (ETFs), bonds, or mutual funds.
Unlike a retirement account, there are no restrictions on how much money a consumer can put in. There are also typically no restrictions on when individuals can withdraw their cash from brokerage accounts. Investors do need to claim any profits–or “capital gains”–as taxable income.
Here’s a closer look at how brokerage firms differ from other types of money accounts.
Brokerage Accounts vs Retirement Accounts
The primary difference between a retirement account and a brokerage account is if there’s any tax advantage at play.
For stocks, bonds, exchange traded funds, mutual funds, options etc, brokerage account holders are liable to pay capital gains taxes on most of their profits from trading these securities. That’s why brokerage accounts are also known in the industry as “taxable accounts.”
Retirement accounts are set up with money that has some kind of tax advantage and can be used to buy securities. For example, 401ks are set up by an employer and funded with money that comes from an employee’s paycheck before taxes and can be matched by an employer.
These accounts, which also include traditional and “Roth” IRAs, have specific rules about the amount that can be contributed and when money can be withdrawn. Meanwhile, with brokerage accounts, there are few limits on funding or withdrawals.
Brokerage Accounts vs Checking Accounts
Brokerage accounts and checking accounts have one important thing in common: they can both have cash in them. Sometimes brokerage accounts will “sweep” your cash into a money market fund managed by that same brokerage, allowing you to earn interest. Meanwhile, in a traditional bank checking account, you don’t earn any interest but you do have easy access to your cash.
An important distinction between brokerage and checking accounts is the level of protection you get from them. A checking account offered by a bank will typically have insurance provided by the Federal Deposit Insurance Corporation, which protects the first $250,000 deposited at a bank that has a charter from the FDIC. This means that $250,000 deposited can be withdrawn even if the bank itself goes out of business.
Brokerage accounts, on the other hand, typically have insurance provided by the Securities Investors Protection Corporation, which unlike the FDIC, is not a government agency. What SIPC insurance does is protect the custody of stocks, bonds, and other securities as well as cash in a brokerage account, not their value.
This means that if a brokerage fails, the SIPC insurance will protect cash deposited in a brokerage account up to $250,000 and securities and cash combined up to $500,000.
This simply means you get your cash deposited in the account and the securities back, not that you have insurance from the value of those securities going down.
Brokerage Accounts vs Cash Management Accounts
Cash management accounts are something of a hybrid between checking and brokerage accounts.
They are not offered by banks but can, on a case by case basis, partner with banks and other financial service providers to give clients access to ATMs and even FDIC insurance.
Should I Set Up a Brokerage Account?
Before you consider opening a brokerage account, make sure you have sufficient money set aside for an emergency fund. Common financial advice recommends setting aside three to 12 times your streamlined monthly expenses. It’s also good practice to contribute to your 401k or IRA before opening a brokerage account.
If you have an emergency fund stashed away and are making regular contributions to a retirement account, think about what types of assets you plan on investing in. A brokerage account would only be required if you plan to buy stocks, bonds, or other securities. If you only plan on investing in mutual funds, you might not need a brokerage account.
What Type of Brokerage Firm Should I Use?
Deciding whether to use a full-service, discount, or online brokerage firm depends on how much and how often you plan to trade, and whether you want someone to manage your money for you.
If you plan to be more hands-on and do your own research, a discount firm might be the best option for you. If you plan on trading frequently, then you probably want to use an online firm that allows you to make trades online or on a smartphone app with little or no fees.
Consider whether you would want access to research (typically provided by a discount firm), or if you plan to make foreign trades (not available from every brokerage firm), or whether you want the ability to make trades 24/7 (online might be your best bet).
If you make frequent trades, remember commission fees can add up over time. This calculator from the U.S. Security and Exchange Commission will help you estimate the cost of commission fees. Once you have decided on the type of brokerage firm you’d like to open an account with, it is worth doing some research on the different firms and their services they offer.
The Financial Industry Regulatory Authority (FINRA) is a self-regulating organization that maintains a database with information on brokerage firms and brokers. Before you commit to a brokerage firm, take the opportunity to review the FINRA’s BrokerCheck service. Doing the research now could help you avoid issues in the future.
How Do I Open a Brokerage Account?
Most firms allow you to set up a new account online. You’ll need to provide basic information including your Social Security number and perhaps your driver’s license. Most firms will ask about your net worth, your employment status, what assets you currently own, and what you have defined as your investment goals.
Additionally, most brokerage firms offer two types of brokerage accounts—a cash account or margin account. A cash account is a type of brokerage account in which the investor must pay for the securities in full. In a cash account, you are not allowed to borrow money from your broker.
A margin account is a brokerage account that allows your brokerage firm to lend you money to buy securities. The securities already in your portfolio serve as collateral for the loan. And, as with any other loan, you will accrue interest when you buy securities on margin.
Another type of account that some brokerage firms offer is a discretionary account. This type of brokerage account, sometimes referred to as a managed account, allows an authorized broker to make trades on behalf of the client. The client usually must sign a discretionary disclosure with the broker. Many brokerage firms require account minimums for this type of account.
How Much Money Do I Need to Open a Brokerage Account?
Depending on the type of brokerage account you are opening, most firms let you open an account with about $1,000 but some require an initial investment of $2,500 or more.
You will need to have enough money in your account to pay for one or more shares of the stock you want to buy plus the commission fee (if applicable). Each account and brokerage firm is different, so check with your preferred company to determine what the account minimums are.
How Do I Fund My Brokerage Account?
There are at least five ways to transfer money from your bank account into your brokerage account:
• Electronic funds or wire transfers involve moving money electronically from one’s bank account into another account. Individuals typically have to go to their bank and fill out the required information and direct where the money should be transferred.
• Deposit a check: Customers can withdraw money via a paper check from their checking, savings, or another existing brokerage account. They can then mail the check to the brokerage account they’d like to deposit the funds at.
• Transfer an existing investment from another broker. Customers can typically transfer funds between brokerage accounts through an automated process known as the Automated Customer Account Transfer Service (ACATS). Customers usually fill out a form. Transfers involve assets such as cash, stocks, bonds, or listed options.
• Deposit an existing paper stock certificate: Paper stock certificates are much rarer today in the age of electronic trading, but if a customer does have one, they can mail it to their broker to be deposited. Inheriting a certificate may require additional verification and paperwork, and in general, mailing with insurance is recommended.
Do I Need to Pay Taxes on My Brokerage Account?
The short answer is yes. Any interest or dividends earned from your brokerage account will be taxable.
If you sell an investment and earn a profit, you will have to pay a capital gains tax. However, if you sell a stock at a loss, that becomes a capital loss and you could get a tax break from that sale which could lower your taxable income.
Investing with SoFi Invest®
If you’re interested in investing but are looking for a low-maintenance alternative to a brokerage account, consider investing with SoFi Invest.
You’ll gain access to our team of financial advisors who are available to offer you personalized advice to help you meet your financial goals. We’ll work with you to determine your risk tolerance and balance your portfolio as needed.
Learn more about how a SoFi Invest account can help you invest strategically to meet your investing goals.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
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