A savings account is a good place to stash money you want to save, but a brokerage account is a must if you want to invest your money. Brokerage accounts allow you to hold many types of investments, including stocks, bonds, mutual funds, and exchange traded funds (ETFs). Here’s what you should know about how a brokerage account works.
Brokerage Account Explained
A brokerage account is a taxable account opened with a stock brokerage firm. With a brokerage account, you deposit money into the account and use it to acquire different investments. In exchange for executing buy and sell orders, the stock broker receives a commission. A brokerage account is almost always necessary if you want to invest, although you can purchase mutual funds without a brokerage account.
There are no limits on how much money you can put into a brokerage account, unlike an IRA or 401(k), and no restrictions on when you can access your money. Depending on the holdings you choose, you may owe capital gains taxes, dividend taxes, and other taxes on your earnings.
A brokerage account allows you to acquire and sell many types of investments. The most popular include:
How it Compares to a Savings Account
- Common stocks that are ownership stakes in a company
- Preferred stocks that don’t usually offer a percentage of the company’s profit but pay higher-than-average dividends
- Bonds like U.S. Treasury bills, notes, corporate bonds, and tax-free municipal bonds
- Mutual funds which are pooled investment portfolios owned by many investors who can buy shares in the portfolio or the trust that owns the portfolio.
- Exchange traded funds (ETFs) which are mutual funds that trade like stocks
- Real Estate Investment Trusts (REITs) that represent pools of real estate-related assets, usually with specialties.
A diversified investment portfolio held through a brokerage account generally provides a much higher return than interest from a savings account. This benefit is enjoyed over the long term, whereas an interest-earning savings account is unlikely to even beat inflation.
Key differences between savings accounts and brokerage accounts include:
- Cash in a savings account is FDIC insured up to $250,000 (per insured bank, per person)
- There is no FDIC coverage for investments, although brokerage accounts offer SIPC coverage of up to $500,000 per institution per person ($250,000 limit on cash in a brokerage account)
- Savings accounts earn interest on deposits rather than access to investment options
You can usually get a checking account from your brokerage firm with the ability to set up automatic transfers (from your brokerage checking or another bank).
Cash vs Margin Brokerage Accounts
You will need to choose between a cash and margin account type when you open a brokerage account. The most common is a cash brokerage account that requires you deposit cash and securities by the settlement date to complete transactions. This type of account won’t allow you to borrow money for trading. With a margin account, you can borrow money and trade on margin. For example, you may only have $10,000 cash in your account, but you can complete a transaction for $13,000 with the margin option. Margin brokerage accounts can offer benefits, but they usually aren’t recommended for beginners due to the risk. With a cash account, you are only risking the money you already have and you can’t go below $0. This isn’t true with trading on margin.
This is just an introduction to how brokerage accounts work. There are many types of brokerage accounts to explore, including online discount brokerage and full-service brokerage accounts, depending on your needs. Make sure you consider your investment goals, strategy, and investment experience when choosing a brokerage account.