If you want to save, you open a savings (or money market) account. If you want to invest, you need a brokerage account.
A brokerage account allows you to buy and sell everything from stocks and bonds to mutual funds, currency, futures and options contracts, depending on the broker. Over the long term, the return on a diversified investment portfolio is much greater than a savings account interest rate, which likely won’t beat inflation.
They differ from savings accounts in the following ways:
- Savings accounts don’t offer you access to investments; instead, you’ll earn an interest rate on money deposited.
- The money in a savings account is FDIC insured up to $250,000 per depositor, per insured bank.
- FDIC coverage does not insure investments, including stocks, bonds and mutual funds. Brokerage accounts carry a different kind of coverage, called SIPC. This coverage protects customers if a SIPC-member broker fails, but it does not protect against investment losses. SIPC coverage is up to $500,000 per customer per institution, with a $250,000 limit on cash.
There are also some key similarities:
- You can deposit as much money as you’d like and withdraw that money at any time (though, with a brokerage account, you may have to sell investments to do so).
- You can set up automatic transfers from another bank or brokerage account, or deposit checks via mail or, in some cases, a mobile app.
- Like banks, many brokerages also offer checking accounts. You wouldn’t purchase investments through a brokerage checking account, but it could be linked to your investment account, making for easy transfers back and forth.
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Brokerage accounts vs. retirement accounts
Brokerage accounts are sometimes called taxable accounts, because the money you earn from investments sold within the account can be subject to capital gains taxes. (Interest from savings accounts and other bank accounts is taxed as income, not capital gains.)
That term also differentiates a standard brokerage account from tax-advantaged retirement accounts, like an IRA or a Roth IRA. These accounts also allow you to invest, but with money specifically designated for retirement. In fact, there are annual contribution limits and often penalties for removing the money before age 59½.
If you’re a beginner investor and your goal is retirement, you should use a tax-advantaged retirement account. If you’ve maxed out your retirement accounts for the year, or you have another goal for which you’d like to invest, you should consider a brokerage account.
Selecting an online broker
You’ll likely want to open an account with an online broker, which will allow you to trade investments easily via its website or trading platform. The best of these brokers also provide research, analysis tools and educational support to get you started.
Before you open an account, survey the options to figure out which online broker is best for you, based on key factors:
Commissions: Nearly all online brokers will charge a trade commission, typically $5 to $10 per trade. (The notable exceptions: Robinhood and Loyal3 offer commission-free trades.) A broker’s commission will apply to trades of stocks, options and exchange-traded funds. You may also be charged a transaction fee for buying mutual funds. However, many brokers offer commission-free ETFs and no-transaction-fee mutual funds that can be purchased with no transaction costs.
Account fees: These include annual fees, inactivity fees, and extra charges for trading platforms, research and data. These charges can be avoided completely in many cases by choosing the right broker.
How often you plan to trade: If you plan to trade frequently, you’ll want to find a broker with low commissions. If you don’t anticipate trading often, be sure the broker doesn’t charge inactivity fees.
Support: What trading technology, educational resources and customer support do you need?
How to open a brokerage account
Once you’ve settled on a broker, signing up for an account will likely require your:
- Social Security or tax ID number.
- Driver’s license or other government-issued ID.
- Employment status.
- Annual income and net worth.
- Date of birth. In most states, you’ll need to be 18 to open your own account. (Looking to start investing at a younger age? Here’s how parents can set up a brokerage account for their kids.)
You’ll need to initiate a deposit or funds transfer (often of a minimum amount, as noted above). The funds transfer process can take anywhere from a few days to a week. Once that is complete, you can begin investing.
A word about margin accounts
During the process of opening your brokerage account, you’ll likely be asked if you want a margin account or a cash account. A cash account is a standard brokerage account, as described above.
A margin account allows you to borrow money from the broker in order to make a trade. When you buy on margin, the investments in your account serve as collateral for that loan until you pay it back. And as with any loan, you’ll pay interest — here, that interest is called the margin rate.
If you’re a new investor, stick with a cash account as you get started. It’s risky to play around with margin (the Financial Industry Regulatory Agency provides a good overview of margin risks). Margin accounts also typically carry higher minimum investment requirements of $2,000 or more, even if the broker’s standard minimum deposit requirement is $0.
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