Are you thinking of taking your finance skills to the next level by learning the ropes of investing? If so — and if you’re considering investing in financial products like stocks, mutual funds and exchange-traded funds (ETFs) — it’s important to understand brokerage accounts and the role they play in helping you invest.
Whether you want to get into the stock market or learn what it means to diversify a portfolio, opening a brokerage account can be one of the most important initial steps on your journey. But first, you’ll want to understand what brokerage accounts are, the ways they work, how they can help you and what you need to do to open one. Use this guide to learn all that — and more — about brokerage-account basics.
What Are Brokerage Accounts?
A brokerage account is a type of financial account that you can use to buy and sell stocks, mutual funds, bonds and ETFs. You can think of a brokerage account sort of like a bank account — except that instead of just saving up money, you can also use it to keep stocks and other assets you choose to invest in. Additionally, your brokerage account keeps you connected to the market because you can use it to track your investments, in addition to buying or selling them.
Years ago, brokerage companies acted as intermediaries between their customers and the stock market, with brokers making trades on their customers’ behalf. While this is still true of some types of brokerage accounts, there are now several different kinds to choose from. Some newer online brokerage accounts offer investors the chance to execute their own trades without ever actually speaking to another person, eliminating the need for a broker to buy or sell stocks for a client.
Are Brokerage Accounts Safe?
Yes, brokerage accounts are safe — as long as you open one through a Securities Investor Protection Corporation (SIPC) member brokerage firm. The SIPC is a federally chartered nonprofit that, among other things, protects investors and the assets in their brokerage accounts — it’s sort of the brokerage-account equivalent of the FDIC and its role in protecting regular bank accounts. Generally speaking, most legitimate brokers are SIPC members. However, if you want to make sure the account you’re considering is protected, you can also search for the brokerage in question on the SIPC member list.
The SIPC is important because it’s almost like a form of insurance for brokerages. If, for instance, the brokerage where you opened your account suddenly went bankrupt, the SIPC would refund the money you had in your brokerage account — as long as that brokerage was an SIPC member.
That said, it’s vital to understand that the SIPC cannot protect you against poor investment decisions. In other words, if you buy shares of a company’s stock for $100 apiece and a month later the price drops to $10 per share, then that loss is yours to cover. The SIPC doesn’t provide any safeguards against market fluctuations.
Online vs. Managed Brokerage Accounts
Opening a brokerage account is almost always the first step in investing in stocks, bonds, mutual funds and other financial assets. But before you jump in, it’s important to figure out exactly what kind of brokerage account is right for your needs.
Full-Service Managed Brokerage Accounts
On one end of the spectrum are traditional full-service brokerages that offer managed brokerage accounts. If you go this route, you’ll have knowledgeable professionals managing your money. These pros, called brokers, get to know your goals and then execute trades on your behalf.
These types of accounts come with the benefit of advice and guidance from professional investors who have ample experience. But they also tend to have higher fees, which are usually calculated as an annual percentage of the assets the broker manages for you. Some also have fees associated with individual trades, so make sure you understand — and are comfortable with — the fee structure before signing up.
Online Brokerage Accounts
At the opposite end of the spectrum, you also have access to commission free-online brokerages with which you can open an account and make completely self-directed trades — sometimes for free. If you’re looking for a more independent approach or one that’s typically more affordable, then this may be the route for you.
Once you open an online brokerage account, you can fund it with money from your standard bank account and then buy and sell whatever assets you want, whenever you want. The primary downside is that you’ll receive little to no guidance on your strategy, so it’s essential to know and understand what you’re doing. On the bright side, many online brokerages now offer free educational tools that can help you learn to make smarter investments.
Cash vs. Margin Accounts
No matter what type of brokerage you choose to open an account with, you’ll be asked whether you’d like to open a cash or a margin account. Understanding the difference is very important, as each comes with a different level of risk.
Cash Accounts
A cash account is straightforward in that you can only use the amount of money you’re holding in your account to buy assets. If you deposit $100, for instance, and invest it all in stocks, then to buy additional stocks you’ll need to either deposit more money or sell one of your current investments.
Margin Accounts
Margin accounts are sort of like the credit cards of the investing world in that they allow you to trade with money that isn’t yours initially. When you open a margin account, you can borrow money from your brokerage to make trades and execute strategies like short selling.
This can be a profitable strategy if you know what you’re doing, but it can set you up for financial difficulties if you don’t. If your trade goes wrong, you may get what’s known as a margin call. A margin call happens when your brokerage asks you to return the money you borrowed, either by depositing more money into your account or selling off an asset. If you don’t, it can sell any of the other investments in your portfolio at will to cover your debt.
How Do You Open a Brokerage Account?
These days, opening a brokerage account is a straightforward process. First, make sure you do your research and find a brokerage that aligns with your goals. If you have friends who are well-versed in investing, ask around to find out if there are any specific brokerage accounts or brokers they recommend and why.
Once you’re ready to open your account, you’ll be asked to provide a bit of basic identity and other information, such as:
- Your Social Security number or IRS taxpayer ID
- Your driver’s license, passport or other government-issued ID
- Employment status information
- Basic financial details like your annual income
- Answers to questions about your investment goals
Most brokerages allow you to sign up online and make the process incredibly easy by guiding you through a step-by-step process. Once your account is open, you’ll be able to connect it to your regular bank account so you can start depositing funds.
If you choose to go with a full-service brokerage, the process may be a little more in-depth as far as targeting your investment strategies is concerned. If you opt for an online brokerage, as soon as your deposit clears you can start trading as soon as you like.
