What is a brokerage account?
Passive income is income where you make your money work for you, instead of you working for money. Sounds pretty cool! It is not a catch phrase, but you really can create wealth by making money work for you. Having money in a savings account is good, but it will not create wealth for you. There are many ways to earn investment/passive income. One way is by investing in the stock market. Stock market returns are one of the highest among all asset classes when compared on a long-term basis.
Why a brokerage account?
If you are interested in participating in the stock market, it is essential to have a brokerage account. A brokerage account allows you to easily manage all your investments from one platform. You can deposit money in your account by cheque or online transfer and then use it to buy and sells stocks/bonds/mutual funds. Brokerage accounts usually involve some sort of a fee on every buy/sell action you take. These fees vary from platform to platform and depend on what kind of features you select for your brokerage account. You must also realize that stocks are not a fixed income investment. You may make or lose money, depending on the movement of the stock price. But over a long term, the riskier stock market tends to give higher returns than fixed deposits and CDs.
With a brokerage account, there are many types of financial instruments that you can invest in. Besides stock, you can invest in real estate investment trusts, exchange-traded funds, sovereign bonds, stock options, various bonds, preferred stocks, and even master limited partnerships.
Types of brokerage accounts
There are two types of brokerage accounts: full-service and discount. A full-service account is exactly what the name suggests; it gives you a full suite of services. You will have a designated account manager or stock broker for your account with a full-service option. This broker will give you advice on where to invest based on your financial goals and risk profile. The broker will also execute buy/sell transactions on your behalf. You can discuss your financial goals and situation with him over the phone or in-person. If you have any questions or concerns, you can speak to your broker. A full-service account is essentially a relationship driven engagement. The fees or commission on a full-service account is significantly higher, as you pay for the personalized attention and service.
A discount brokerage account, on the other hand, is a no thrills no frills version of the full-service option. It is normally an online account where you decide what to buy and sell. There is no guidance or advice on industry/sector/risk profile with a discount brokerage account. You will be on your own and do things yourself. While you pay significantly lesser fees on a discount account, there is a risk of making mistakes and losing money in case you make a mistake choosing the stock. If you are confident about what you are doing and understand investing, or if you are comfortable doing your own research, then you will save a lot of money with a simple online brokerage account.
There are two other types of accounts that you may come across in your research. One is called a cash account and the other a margin account. It is very important to understand the difference between these two types of accounts. A cash account is a simple trading account where you use the money you deposited to buy stocks/investments. When you buy, money gets deducted from your account and when you sell money gets deposited. However, this settling of funds when buying and selling takes some time. So until the transaction is settled, you cannot make more trades.
For example, if you sold a few stocks today morning, you may see the money in your account maybe tomorrow. If you were to spot an amazing investment opportunity in the afternoon, you cannot buy because the money in your account from the earlier sale has still not shown up. That is where a margin account can help. In a margin account, you can borrow money from the broker to make trades. You have to pay interest on the borrowed money, but for professional everyday traders, margin accounts have their benefits. You may have to pledge collateral in order to enjoy the right to borrow. So, there is clearly an added risk in opening a margin account. If you are a beginner or an occasional trader, then it is best to go for a cash account. A margin account is for professionals and people who really know the ins and outs of trading.
Features to know when comparing various services
There are many companies offering brokerage services throughout the country. There is a lot of competition and various brokerage firms have varying features. The key is to know your preferences and situation and accordingly select the best service for your needs. In order to compare services, you need to first know what are the most common features offered by brokerage services. Following are the important ones that you must educate yourself about:
- Investment options available: The most important thing to look for in any brokerage account is the range and types of investments that it offers. There are different financial instruments listed above which you can invest in using your brokerage account. Search if a firm offers the instruments that you are looking for. If you are planning to invest in futures, does the firm offer futures and options? If you want to invest in a REIT, is that available? Study the website and call the company if needed to verify.
- Cost: As mentioned above, various brokerage firms have different types of fee structures. Some charge a fixed amount on every trade, while some do not. So, if you are going to be trading often, look for a firm which charges a low per-trade fee. Certain brokerage firms do not charge fees for the purchase of ETFs and mutual funds. So, if you are only interested in those two, then look for a firm which waives fees on them. Secondly, firms may also charge inactive fees. If you are not going to be a frequent trader, then find a brokerage account which does not charge you for not making trades often. Thirdly, there are fund withdrawal fees, where you get charged a fixed amount whenever you transfer money from the brokerage account to your bank account. Such fees might be ok if you are not planning to deposit and withdraw frequently, but they may be a problem if you will be moving money frequently.Lastly, depending on the level of service you select, there will be account fees. These are fees for qualified experts providing you with research, answering your queries, engaging with you for financial planning and so on. Study all of these fees and figure out what is appropriate for your situation.
- Minimum balance: Some brokerage accounts have a minimum balance that you need to trade initially to even open an account. If you do not have a few thousand dollars to invest, then look for a brokerage account which does not have such minimum balance requirements. Sometimes, these minimum balance fees may vary depending upon how much you invest. Know your investment capacity and select an account accordingly.
- Customer Service: Find out what kind of customer service the brokerage firm offers. Is it 24/7? Is it phone and email support only? If you are someone who prefers to speak with a designated person every time, then what are the fees to have a full-service account with an account manager? The level of personalization will increase or decrease the price that you pay for customer service. Know your preference and then search for the best offering.
Some other things to consider
Traditional IRA investment is not taxed until withdrawal, while Roth IRA contributions are taxed but have benefits during withdrawals. Many companies match your contributions up to a certain limit on 401k programs. If that is the case, it is important to take advantage of such contributions. After you have taken full advantage of contribution benefits and tax benefits from 401k, IRA and Roth IRA investments, only then consider investing retirement money directly in stocks. After all, income from stocks is taxable and stocks, in general, are a risky investment when done directly.
Opening a brokerage account is not difficult at all. You only need to fill out personal information, provide some identification, mention your tax ID number, and provide your social security number. With technology, a brokerage account can be opened from the comfort of your living room. Dedebt helps investors and individuals open brokerage accounts and guide them through the process. Feel free to fill out the form below or call us and one of our experienced professionals will guide you through the entire process.