How To Open A Brokerage Account
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Opening a brokerage account may seem tedious and daunting, but it is a piece of cake. The most difficult part of your process is deciding who to use and what type of brokerage account you want. You'll need to decide what you are trying to accomplish with the brokerage account and how you plan to trade and understand that certain features will be better suited for specific trades and investors.
Here, I'll look closer at brokerage accounts and how you can open one.
In this article
What is a brokerage account?
A brokerage account is an account that allows you to buy and hold investments like bonds, stocks, mutual funds, and exchange-traded funds (ETFs). You can open an account with the brokerage firm and the firm will purchase and sell the investment assets in the market for you. This firm will also be the custodian for the securities you own in the brokerage account.
Types of brokerage accounts
There are four main types of brokerage accounts, and you can open them with a brokerage firm, but the investment you hold in each account will be segregated for taxation.
1. Taxable investment accounts
In a taxable brokerage account, you will pay regular income tax on the dividend or interest you earn. You will also have to pay tax on the gains on the sale of your investment. It allows you to deposit as little or as much money as you want to in the account.
2. Retirement accounts
In a retirement account, you will have to deposit money in a traditional IRA or a Roth IRA. Self-employed individuals can open a SEP IRA or solo 401(K). You will have to follow the different rules regarding contribution limits and taxation in this account. Retirement accounts also have rules regarding who qualifies to open and contribute to the accounts.
3. Cash account
If you have a cash brokerage account, you purchase securities with the money deposited in the account. Hence, if you have $500 in the account, you can buy assets worth $500. You cannot buy securities if you do not have money in the account.
4. Margin account
The margin account will allow you to borrow money to purchase investments, and these investments work as collateral for the loan. Now, if you have $250, you can buy stock for more than $250. The additional amount will be a loan that allows you to buy additional stock. But you will have to pay interest on the loan.
You can execute complex trading strategies like short selling with margin accounts. However, there is a risk associated with using debt to invest. In case the value of the investment falls, the brokerage could ask you to pay back the margin debt instantly. It is known as a margin call. If there is an account deficit, the firm can sell your investments without notice.
As a beginner, it is best to open a cash account and buy securities from the funds you have in the account.
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How does a brokerage account work?
It is important to understand the functioning of a brokerage account. You deposit cash in the account, which is used to buy bonds, stocks, ETFs, mutual funds, and other investment assets. You can use the account for day trades and earn short-term profits or for investing for the long term. A lot of accounts provide different ways to earn a good yield on the amount that is uninvested.
The brokerage will act as the custodian for the securities you own and maintain the account. It is an intermediary between the market and you, buying and selling the investments per your instructions. Brokerage accounts are also taxable investment accounts, and you can open an account at a discount, online, or with full-service brokers.
The fees and accounts minimum requirement will vary. You may have to meet the regulations of the brokerage firm with which you are opening an account. Some firms also charge management fees or commissions to purchase or sell the assets.
Your money is very safe in the brokerage account. The funds are insured by the Securities Investor Protection Corporation (SIPC), which covers the custodial function of the brokerage. Hence, if the brokerage firm goes bankrupt, it will replace the customers' cash and assets. However, you will not be protected from bad investment decisions or loss in value of the investment for poor investment advice.
Where can you get a brokerage account?
There are different kinds of brokers where you can open your account.
Online brokers
If you understand investment and assets, an online brokerage account is ideal. It allows you to manage the investment portfolio yourself with minimal guidance from professionals or algorithms. You simply need to open an account and self-select the investment. It has zero trading commissions and low fees.
Related: Best Brokerages for Beginners
Robo-advisors
If you are a beginner and new to investing, robo-advisors can make your investment journey easier. It uses algorithmic investing strategies, keeping your investment goals in mind. You will have to answer a few questions about risk tolerance, financial goals, and the purpose of investing, and the robo-advisor will use the algorithm to design a portfolio that fits your needs. Stash is one such robo-advisor that offers automatic fund balancing, keeping your goals in mind. But they do come with a fee.
Related: Best Robo Advisors
Managed accounts
Financial advisors and full-service brokers offer brokerage accounts that expert professionals handle. These professionals are experts in the field of investing and want to know your circumstances before selecting investments based on your goals. With this account, you can access advisory services about all aspects of financial life, like retirement planning, and the advisory fee for the service is the highest.
What type of brokerage account should you choose?
The type of account you choose will depend on your investment objectives, the time you can devote to handling the portfolio, the cost, and your investing experience. If you only want to buy a couple of stocks and keep it simple, opt for an online brokerage like Vanguard. You can also have a professionally managed account through E*TRADE.
When you have a self-directed approach, you need to keep in mind that in case the market falls, you will not have anyone to guide you or hold you from making wrong investment decisions.
Alternatively, you can work with a financial advisor that gives you access to professionals who have market knowledge and understanding. If you can take complete advantage of the managed brokerage accounts, you can build a portfolio that matches your goals.
Between these two, some robo-advisors are perfect for those who do not want to make all the decisions but do not want to pay a high price for a managed brokerage account.
Conveniences and services to consider
Before opening a brokerage account, you need to remember that pricing isn’t everything. Of course, it is best to find the lowest price, but there are other things you must keep in mind when picking a broker.
Resources and research
Many brokers give their stock ratings and access to third-party research. This will help make the right investment decision. The more access you have to resources, the better decisions you can make.
Foreign trading
Brokers offer the convenience of converting the money in your account into foreign currencies to trade on the international stock exchanges. In case you are keen on this, pick a broker that allows you to do this.
Fractional shares
This is very important for new investors. If you do not have the funds to afford an entire share right from the start of your investment journey, you can buy fractional shares and own a part of the share.
Trading platforms
Some brokerages offer a range of mobile apps and software, allowing you to check out their platform before opening an account. You can also access a demo version of the platform to get an idea of how it works. Remember to check the mobile app reviews if you prefer to have the account on the go.
Convenience
Several brokerages have a wide network of local branch offices you can visit for personal advice, while many others do not. If you like the human touch and personal connection, you need to look for a brokerage that offers the service. The brokerage should have a physical presence where you can go and speak to the investment advisor.
Investment strategies
You must consider your investment strategy before you zero in on a brokerage platform. If you want to play an active role in choosing investments, you should opt for brokerages like E*TRADE or Charles Schwab. But if you are a beginner and do not want to take a hands-on approach, opt for an automated brokerage account like Betterment.
Security offerings
All the brokerages have different traceable securities you can choose from. Ensure that the broker offers the security you are looking to invest in. For example, not all brokerages offer fractional shares, so you must check thoroughly before committing to a brokerage firm.
Fees and commissions
Many brokerages like Charles Schwab charge $0 commission on the trade, but you need to keep in mind that trading is not completely commission-free. You will have other costs and fees involved beyond this commission, and you need to understand the other expenses and fees charged by the brokerage. It is important if you want to dabble in mutual funds or options. When opening a brokerage account, make it a point to check the annual fee schedule and compare the costs involved in the transactions. While pricing is not the only thing you need to consider, it is one of the important things you need to keep in mind.
Step-by-step guide to opening a brokerage account
Step 1: Choose the brokerage
Consider the different types of brokerage accounts, and the type you choose will depend on your investment goals. You can choose a full-service brokerage firm offering financial consulting, but the price could be steep. Alternatively, you can choose discount brokers that charge lower fees but may not have access to additional financial advice or planning services. Lastly, there are online brokerage firms that only allow you to invest through their website.
Before you decide to work with an individual investment firm or advisor, you must check on their background. You will find details on the Financial Industry Regulatory Authority (FINRA) by simply entering the name of the firm or the broker’s name. Here, you can learn about the broker’s history, regulatory actions, past complaints, or current arbitrations.
Step 2: Sign up for the account
You can open and operate the account online. Most brokers do not charge a fee for opening an account, but they may need account minimums. Some brokerages have no minimum deposit requirement. You can open as many accounts as you want and hold multiple accounts in brokerage firms. You will need to provide the following details:
- Personal information, including the home address and phone number
- Social Security Number
- Name and address of the employer
- Personal net worth
- Your annual income
Additionally, you may have to answer questions specific to the type of brokerage account you choose. You may also have to choose a core position or an account where your money will be held till you invest it, like a cash account. It is possible to change this selection after opening the account.
Step 3: Fund the account and start trading
Funding the account immediately after opening it is not mandatory. You can decide when you want to fund the account and the brokerage will ask you to link the savings or checking account with the brokerage account. You can also wire funds to the account. After funding the account, be careful about choosing the investments. How and what you invest in will be based on your goals and time horizon. If the firm offers education tools, you can use them to make informed decisions. There is no limit on the amount you can invest in the taxable brokerage account. Once funds are in your account, you can start trading in securities.
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The bottom line
Opening a brokerage account is a very simple and hassle-free process that allows you to invest in securities. Be careful when choosing the account because it will depend on the objectives and whether you want to let the experts handle the account or take a hands-on approach to investing.
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Editor
Vandita Jadeja is a financial writer and editor at Joywallet. She loves to read and write about money and brings a decade of experience from the financial industry.
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