It doesn’t matter whether you’re a beginning investor or Warren Buffett, if you want to invest in the stock market, you’ll need two things: money and a brokerage account.
Everyone knows what the former is, but what about the latter?
What is a brokerage account? A brokerage account is a taxable account an investor opens with a brokerage firm; after funding their account, investors can place orders to buy and sell stocks and other investments. The broker fulfills those orders on behalf of the investor, typically charging a commission, or fee, to do so.
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Technically, there are two main types of brokerage accounts: cash accounts, in which all investment purchases must be fully funded by the investor; and margin accounts, which allow the investor to use borrowed funds from the broker to finance a purchase. Option accounts fall under the category of margin accounts.
Consider the term “brokerage account” to refer to cash accounts, the most common brokerage account and the type most people refer to when they use the term.
What to do before setting up a brokerage account. It’s normal to be antsy to start investing, especially in a rising market. But before you run off and deposit your money with the first broker you can find on Google (ticker: GOOG, GOOGL), slow down, take a deep breath, and examine your situation.
“Typically when people get involved in investing, it often begins with a goal or a set of goals. First and foremost, you want to be able to identify that goal,” says Greg Vigrass, president of Folio Institutional. “Your goal could be a home, retirement, children’s education or a large luxury purchase.”
Then, make sure your finances are in order. “Depending on your situation, you should have at least six months of cash reserves on hand for emergencies,” says Thomas Walsh, certified financial planner and portfolio manager with Palisades Hudson Financial Group’s Atlanta office.
“Also, make sure you are contributing enough to any retirement plans you may have available, whether it be a company-sponsored 401(k) plan or Roth IRA, among other options,” Walsh says, echoing best practices that experts suggest before investing in stocks.
Once you have a clear goal and enough capital to comfortably invest, it’s time to start looking for the brokerage firm that will best suit your needs — and there certainly will be plenty that crave your business.
How to find the best brokerage account for you. Commission fees are the most important differentiator for most investors when choosing brokers, and they will vary widely depending on how much value you want your brokerage firm to provide in the investing process.
Full-service brokers are the most expensive, but also provide the most hand-holding.
“Full-service brokers would pretty much walk you through investments. They typically charge anywhere between $50 for a trade — whether you buy or sell a stock — all the way up to $250,” says Steve de la Fe, CFO of Taxfyle. They also sometimes calculate commissions as a percentage of the overall purchase.
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Examples of full-service brokers include Edward Jones and Raymond James.
Since the rise of the internet, however, online brokers have become more prominent, and today most online brokers offer commissions of less than $10 per trade. The trade-off, remember, is that you won’t have the personalized financial advice full-service brokers offer.
Low-cost online brokers like Etrade, TD Ameritrade, Scottrade and others have helped democratize investing.
In recent years though, brokerage accounts with no fees at all have been made possible.
“There’s also some startups popping up like Robinhood that don’t even charge on commission so you can buy and sell stocks free of charge. It’s a very good option for people who are budget conscious,” de la Fe says.
He cautions, however, that cheap or free brokerages can also mean less tools, worse user interfaces, or fewer stock research resources. “Do they give you the right types of tools you need to use to make informed decisions?” de la Fe asks.
Other things to be aware of that can differentiate brokerages with similar commission structures include: account minimums, account maintenance fees, the option of physical branches, and more limited investment options. Mutual funds, for example, aren’t currently supported on Robinhood.
How to open a brokerage account. Once you’ve made sure you’re ready to invest, figured out your priorities, and found the best brokerage for you, figuring out how to open a brokerage account is fairly easy.
You’ll have to fill out some forms, give some personal information and link your bank account to provide funds, but the instructions should be clearly laid out and easy to follow on the brokerage firm’s website.
The freedom to invest as you please. “There’s a lot of substitutes to brokerage accounts, but not directly. You have traditional IRAs and Roth IRAs and 401(k)s, and those are great substitutes. The only issue with each one of those is you’re limited to contributions per year,” de la Fe says.
There are no limits on what you put into or take out of your brokerage account. That freedom, as well as the freedom to choose from thousands of different stocks, is what makes these accounts so attractive.
[See: 7 of the Best Stocks to Buy for 2017.]
“With a brokerage account you have a lot more opportunity to make a lot of money as opposed to just putting it in the bank or a money market account and earning nominal interest on those liquid assets,” de la Fe says. “But the risk is a lot higher as well.”
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What Is a Brokerage Account? originally appeared on usnews.com
