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If you want to buy stock or other investments, you need a brokerage account. But many people don't even know what a brokerage account is, let alone how to open one or what to look for in a broker. Here, you'll learn everything you need to know about brokerages so you can find the one that’s right for your investing needs.
A brokerage account is a financial account that allows you to buy and sell stocks, bonds, mutual funds, currencies, futures, options, and other types of investments. Many financial institutions offer brokerage accounts to investors.
Brokerage accounts work a lot like bank accounts. As with bank accounts, you can transfer money into and out of your brokerage account whenever you like. Typically this is done via linked bank accounts. Some brokers even let you deposit money via check.
But there are major differences between bank and brokerage accounts. Brokerage accounts let you make higher risk-reward investments in things like stocks and ETFs, but bank accounts offer stable returns with lower potential downside. FDIC insurance protects banking customers from bank failure, and SIPC insurance protects brokerage customers from brokerage failure. But SIPC insurance does not prevent investors from losing money to typical market volatility or underperforming investments.
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There are many different investments available in brokerage accounts. They include the following.
Common stock gives investors stake in a company. When you think of investing in the stock market, you're probably thinking of common stocks. Common stock is known for offering the following:
Companies most often use common stock to raise money through equity financing. For instance, companies seeking capital for the first time typically issue common stock in an initial public offering, or IPO. That gives the business cash and stock buyers a stake in the business. Investors typically buy common stock to own stakes in individual companies they believe will outperform the broader market.
Preferred stock gives investors stake in a company, but it’s different from common stock in a handful of ways:.
Basically, preferred stock is less risky than common stock. Should a company fail, preferred stock owners are more likely than common stock owners to get their money back. But preferred stock doesn't offer as much upside potential as common stock.
In many ways, preferred stock works like a bond. Preferred shareholders usually earn fixed dividend payouts on a predictable schedule, expecting to get back the money paid for the shares later on. The price of preferred stock often moves more with the bond market than with the stock market -- especially when interest rates are volatile. Investors typically buy preferred stock to earn fixed dividends on lower-risk stock.
Bonds are loans that investors make to companies or governments. Bonds don't represent ownership in a company -- they represent debt the entity must repay.
In exchange for getting investors' money, the company or government agrees to make fixed interest payments over the course of the loan. At maturity, the entity then repays the principal amount in full. Investors typically buy bonds to earn stable interest payments.
REIT stands for real estate investment trust. REITs collect money from shareholders to invest in various types of real estate. In some cases, REITs buy commercial or residential property and then lease it out to collect income. Other REITs prefer to build their own buildings, or to trade financial securities tied to the real estate market.
REITs are like mutual funds, except they focus only on real estate. Each share of a REIT represents a fractional interest in all the real estate in the REIT's portfolio. Managers of the REIT decide which properties to buy and sell. Investors typically buy REITs to own diversified stakes in the real estate market.
Money market accounts are like savings accounts, but with some additional features that often include check writing and higher interest rates. Certificates of deposit, or CDs for short, pay investors monthly or quarterly interest in exchange for locking up investments for a fixed period of time (three months to five years, typically).
Both types of accounts often offer better returns than checking or saving accounts, but they come with their own drawbacks, like early withdrawal penalties or investment minimums.
Mutual funds are investment vehicles that let many different investors pool their assets together, with fund managers who then take the money to assemble a portfolio of stocks or other investments.
Mutual funds come in two types: actively managed vs. index funds.
Actively managed funds have dedicated fund managers who pick stocks in the hopes of finding top returners. They typically charge investors high fees to cover the cost of research and management.
Index funds passively track popular market benchmarks like the S&P to match their performance. Compared to actively managed funds, they charge low management fees.
Owning shares of a mutual fund entitles you to a portion of any gains in the fund's portfolio -- and any losses, too. Investors typically buy mutual funds for professional management or broad exposure to an asset class.
Exchange-traded funds work a lot like passively managed mutual funds, the main difference being that ETF shares trade on major stock exchanges. Like mutual funds, each ETF share represents a fractional stake in the fund's portfolio. Most ETFs use an index tracking strategy to match the returns of specific markets. But recently, actively managed ETFs have become more popular. These attempt to beat market indexes like the Nasdaq and may be linked to specific categories, like artificial intelligence companies. Investors typically buy ETFs for broad exposure to an index or category.
Master Limited Partnerships (MLPs) are publicly traded business partnerships. MLPs offer tax benefits, and you'll most often find MLPs in the energy infrastructure and transportation industries.
MLPs typically offer investors high yields compared to bonds thanks to a combination of tax advantages and strong cash flows. But they're considered riskier than bonds and can complicate taxes. Investors typically buy MLPs to collect quarterly, tax-advantaged earnings.
Not sure where to start? Consider opening an account with a beginner-friendly broker. You can typically do so at zero cost. Do your research and start small -- you'll learn more from losing money to the market than you will reading whole books on investing.
Brokerage accounts are useful, but they come with costs. Below are the most common broker fees.
Brokers charge several types of fees. These can include:
Brokerage companies used to charge commissions for trading, but commissions have become less of a big deal lately. Many brokers now charge no commissions at all for stock and ETF trading. Nevertheless, it's smart to look at a broker's fee schedule to avoid surprise expenses.
Some investment types charge management fees. For instance, mutual funds and ETFs typically have annual expense ratios that cover the costs of management. Those fees don't necessarily show up on a brokerage statement; rather, they're taken directly out of the fund shares' value.
Full service brokers may charge management fees for actively managing accounts and performing other services.
In simplest terms, the key difference between a cash account and a margin account is that cash accounts don't let you borrow money to buy more stocks. In order to borrow against the value of your investments, you must have a margin account.
With cash accounts, you're responsible for funding transactions. If you don't have cash in your account, then your broker typically won't let you trade. Similarly, when you sell a stock, you'll have to wait until the trade settles to withdraw your payout or use it to buy more shares of another company.
Margin accounts let you borrow from your broker. You can borrow against the value of your stocks and other investments to buy more investments, giving you access to leverage. In exchange, the broker collects interest on your loan. Limits on margin loans vary, but many let you borrow up to half your account value.
The biggest risk of margin accounts is that your broker can force you to sell stocks if your account balance falls below a critical limit. This is called a margin call and it often happens at the worst possible time. Beginner investors may want to steer clear of investing on margin.
When researching brokerages, you may find that both discount brokers and full-service brokers exist.
Historically, all brokers were full-service brokers who managed trades for investors. Stock trades used to be regulated, charging hundreds or even thousands of dollars per transaction. That started to change in the 1970s, when discount brokers first came into being.
Discount brokers allow you to buy and sell stocks or other investments online. You can trade on your own behalf, and the fees involved have been majorly reduced.
Full-service brokers are still useful for clients who are willing to pay up for personalized service and hands-off management. But for those of more modest means, the dozens of reputable online stock brokers offer compelling features:
There are plenty of great brokerage accounts to choose from. But making your final decision on which brokerage to pick can feel intimidating.
You can narrow them down by looking for a few things in particular:
Here's a simple seven-step process for opening a brokerage account:
Uncover the names of the select brokers that landed a spot on The Ascent's shortlist for the best online stock brokers. Our top picks pack in valuable perks, including some that offer $0 commissions and big bonuses.
A brokerage account is a financial account that lets you buy and sell stocks, bonds, mutual funds, currencies, futures, options, and other types of investments.
A full-service brokerage account gives you access to investing experts who help manage your portfolio, plan your finances, and minimize your taxes. A discount or online brokerage account gives you the tools you need to manage your own investments.
You can trade stocks, bonds, REITs, money markets, CDs, mutual funds, ETFs, MLPs, and other investments with a brokerage account.
Although most online brokers have eliminated trading fees, there might still be fees for trading mutual funds, options, etc. Some brokers also charge annual fees for having an open account, as well as inactivity fees for not trading enough. Some charge subscription fees for access to investment research and tools.
Look for diverse investment options, reasonable fees and commissions, affordable account minimums, educational resources, research tools, and reliable access. These features will indicate you've found a good brokerage account.
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