A brokerage account is a type of account many investors use to buy and sell securities. You can think of them as a bank account used exclusively for trading.
In fact, many banks offer brokerage accounts. Not only that, but several companies that previously only offered brokerage accounts now offer checking, too.
How Do Brokerage Accounts Work?
A brokerage account, or taxable brokerage account, is funded with after-tax dollars. In other words, these accounts don’t have any tax advantages the way an IRA or 401k does.
That means you also have to pay capital gains tax, which is a tax on the growth of your investments.
Despite not having the same advantages as retirement accounts, there are still several reasons to open a brokerage account.
For one, retirement accounts have contribution limits. Once those contribution limits are reached, you can no longer contribute to your retirement accounts in the current tax year.
Plus, 401k programs often come with a limited number of funds that may have high fees. With a brokerage account, your investment options are virtually unlimited.
That’s not to mention the fact that if you want to be a day trader, you’ll need a brokerage account.
Having a checking account and brokerage account under the same roof can be convenient. That’s because you have to transfer money into your brokerage before you are able to trade.
As soon as you open and fund your account, you are ready to start trading. It’s really quite simple - the part that can be more complicated is researching investments and managing them.
Brokerage Account vs. Tax-Advantaged Accounts
As mentioned above, tax-advantaged accounts - namely, retirement accounts - do come with advantages. Accounts such as 401k, 403b, and 457b are all funded with pre-tax dollars.
That means you don’t pay income tax on that money as it it is deposited. It also grows tax-free, with no capital gains tax.
This also has the benefit of reducing your taxable income. Each dollar your earn in high income brackets is taxed at high rates. So, if your retirement contributions knock you down a tax bracket, not only will you pay no tax as the money is going in - you’ll also have a lower tax rate overall.
Of course, the money is taxed when it is withdrawn, so it’s not all good news.
Roth accounts such as a Roth IRA or Roth 401k are similar. The only difference is when the money is taxed: as it’s deposited. Then, you can later withdraw it tax-free.
Thus, having both a traditional account and a Roth can afford you some tax flexibility.
All of these tax advantages show how a retirement account is advantageous to a brokerage account.
However, money in a retirement account can’t be withdrawn before age 59 & ½ without a 10% penalty. The only exception is a Roth account, which has no such penalty.
In any case, there is no age-based penalty for withdrawing money from a brokerage account. You will have to pay capital gains tax, however.
How to Open a Brokerage Account
If you open a brokerage account online, the process only takes a few minutes. All you have to do is fill out the application and you should be approved right away.
The next step is to add money to your account. If you decide to open a checking account with a brokerage firm that offers them, you can move money from that account to your brokerage account.
If not, you’ll have to link your outside checking account and transfer money in. It’s easiest to do so electronically, but there should be a paper check option if you prefer that.
Either way, moving money from a bank account to your brokerage is like any other bank transfer. In other words, it takes two to three business days.
If there is any mention of a margin account, it’s worth noting that these aren’t necessary for most investors. Margin accounts are mainly used by experienced day traders. If you are looking to invest passively, that isn’t something you would need.
Why Do I Need to Invest?
Investing is one of the best ways to grow your wealth. It’s possible to set up your investments so that they require little to no ongoing maintenance.
Plus, with defined benefit (pension) plans and Social Security not being what they once were, it’s becoming increasingly important for Americans to invest their own money.
When I was younger, I believed investing was essentially the same thing as gambling. But while investing can be volatile at times, it’s wrong to think the two are the same.
After all, gambling is a business meant to make money for casinos, lotteries, etc. They are specifically designed so they will always bring in more money than they give out.
Investing isn’t like that at all. Stocks are issued as a way for businesses to fund projects, pay off debt perform research, and more. They then reward investors who were willing to put up the money to help fund their growth.
Plus, investing doesn’t have a “jackpot” the way gambling does; it’s mostly a long game. So, investors wouldn’t put money into it if the house always won.
Thus, while investing can be misunderstood as gambling, it usually isn’t. Given a long enough time frame with a diversified portfolio, investors will almost always come out ahead.
Thanks to compounding interest, the longer you invest, the more you win.
Indeed, whether you are saving for a vacation or simply want to financially secure your retirement, investing is a must.
Where Should I Open an Account?
There are different types of brokerage accounts you can open - from opening an account with a stock broker to opening an account with a low-cost online brokerage.
These days, the definition of a brokerage account is broader than ever. It not only includes accounts at traditional brokerage firms, but can be expanded to include services like Betterment and M1 Finance.
Betterment is a robo-advisor that does all the work of managing your investments for you. While it has expanded its offerings to include savings and checking, investment accounts with Betterment are indeed considered brokerage accounts.
M1 Finance on the other hand is a hybrid, allowing you to fully automate your investments. But it also allows you to build a custom portfolio to your liking.
As an aside, if you are specifically looking to day trade, an account with Betterment or M1 Finance won’t work. You’ll need a traditional brokerage account for that.
All of these are examples of brokerage accounts you may want to open.
What you ultimately choose will likely come down to fees, how much time you want to spend managing your investments, and whether you need guidance from a human advisor.