Brokerage Account: What It Is & How It Works

Updated: May 26, 2022Written By: Kent ThuneReviewed By:

A brokerage account is a type of trading account that can be used to buy, hold, or sell a broad range of investment securities.

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What Is a Brokerage?

A brokerage is a firm that offers both retirement and taxable investment accounts. Brokerages will assist clients in the buying and selling of tradable securities for their accounts. Officially, security trades occur in the brokerage's name, and security positions are held in the brokerage name. A brokerage passes along the benefits of security holdings to the clients who own the account, including dividend payments and voting privileges.

What Is a Brokerage Account?

Although brokerages offer both non-taxable and taxable accounts, traditionally a brokerage account is defined as a taxable account. Tax-protected accounts like IRAs are commonly referred to as retirement accounts, as opposed to brokerage accounts.

Brokerage accounts can be used for trading investment securities, such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). It can be opened for an individual, more than one person, or on behalf of a minor.

Many investors may use a brokerage account as a supplement or as an alternative to retirement plans such as an individual retirement account or 401k. Investors who want to save and invest on behalf of a minor, or those who want to trade on margin, may also choose to use a brokerage account.

Important: While IRAs and brokerage accounts are types of trading accounts, they are not the same. The primary difference between these investment account types involves taxation. An IRA is a retirement account and is often called a "non-taxable account," whereas a standard brokerage account is often referred to as a taxable account" or non-retirement account.

How a Brokerage Account Works

A brokerage account allows an investor to deposit money and to buy, sell, and hold investment securities. A taxable brokerage account has no contribution limits, no penalties for withdrawals (other than taxes), and greater flexibility than other investment and savings vehicles, such as retirement accounts.

The different types of brokerage accounts are:

  • Individual brokerage account: Also known as a standard brokerage account, this account is registered in the name of only one account owner. Capital gains, dividends and interest are taxable. Investors can open and fund the account with cash, including margin accounts.
  • Joint brokerage account: Commonly held by spouses, the account is shared by two or more individuals. Capital gains, dividends and interest are taxable. Investors can open and fund the account with cash, including margin accounts.
  • UGMA/UTMA minor account: This is a Uniform Gift to Minors Act (UGMA) account or Uniform Transfer to Minors Act (UTMA) account. These are custodial brokerage accounts controlled by a parent or other adult relative. Account assets are held in the name of the minor until the child reaches the age of majority, which varies by state.

Tip: Many brokerages now offer commission-free trading on stocks, ETFs, and option trades. Depending on the brokerage or investment company selected, thousands of mutual funds may be accessible with no transaction fees, while other funds may incur fees or sales charges. Investors may pay interest charges for borrowing on margin including when they conduct short selling.

Brokerage Account Requirements

Brokerage accounts require the investor to provide personal information, such as their legal name, date of birth, and Social Security Number.

Other requirements include:

1. Minimum Investment Requirement

Most brokerages do not require a minimum deposit to open an account, however, investors may be required to meet minimums on some investments. Some mutual funds have minimum initial investment requirements of $1,000 or more. Stocks and ETFs are commonly tradable at zero commission, making the minimum amount required equal to the cost of one share. Some brokerages may offer the purchase of fractional shares.

2. Margin Account Minimum Equity Requirement

If an investor opens and funds a margin account, FINRA Rule 4210 requires that investors maintain a minimum of 25% equity in the margin account at all times, or at least $2,000. Some brokerage firms may have margin requirements that are higher than the minimums set forth by regulatory bodies.

3. Minimum Age Requirement

Brokerage accounts have a minimum age requirement of 18 years old. However, as mentioned above, parents or adult relatives of a minor child may open a minor account, which will be either an UGMA account or UTMA account, depending upon the account owner's state of residence. The UGMA/UTMA are controlled by the adult until the minor reaches the age of majority, which varies by state.

Brokerage Account Costs

Brokerage account costs vary, depending upon the brokerage firm and the types of investments, trading, and services that the investor uses. For example, an investor who only trades stocks and ETFs at a discount broker might pay $0 in direct fees. But a full-service brokerage may charge an investor up to 1.50% of assets under management per year.

  • Full-service brokers typically charge higher transaction fees, sometimes reaching $150 or more per trade.
  • Stocks and ETF transactions are commission-free at many discount brokers but others may charge $7-$10 per trade.
  • Discount brokers don't typically offer fee-based advice but a full-service broker may charge 1.00-1.50% per year for assets under management.

All brokerage firms typically charge a fee for options trading and charge interest rates on margin accounts.

Note: Just because there are no direct fees does not mean investors aren't charged for brokerage services. Bid-ask spreads and management fees of ETFs and other funds make up two costs to investors. There may be other costs as well.

Pros & Cons of a Brokerage Account

Pros

  • Range of registration types: A brokerage account can be opened for an individual, more than one person, or on behalf of a minor.
  • Withdrawal flexibility: Investors can withdraw available cash from a brokerage account at any time for any reason.
  • Investment choices: Brokerage accounts may be used to trade a wide range of investment securities and can be used to purchase options or buy on margin.
  • Low costs: Many discount brokers offer commission-free trades on stocks and ETFs, as well as thousands of "no transaction fee" mutual funds.
  • No maximum contribution: In contrast to IRAs and 401k plans, there is no maximum contribution amount for a brokerage account.

Cons

  • Not tax-advantaged: Capital gains, dividends and interest are taxable to the investor.
  • Probate asset: In absence of a trust, and in the event of the account holder's death, the assets held in a brokerage account must pass through the probate, which is potentially a costly and time-consuming process.

Alternatives to a Brokerage Account

Although IRAs can be opened with brokerage firms, they are traditionally not classified as brokerage accounts. Retirement accounts like IRA and 401k accounts can be alternative methods for gaining access to investment markets. Investors have many of the same trading capabilities and investment choices with an IRA as they would with a standard brokerage account. For example, investors may trade stocks, bonds, ETFs, mutual funds, and options in an IRA. However, buying on margin is not allowed in an IRA.

401k plans generally limit investment options to a select group of mutual funds with limited trading capabilities. Margin trading is allowed not permitted within 401k plans. In some cases, a self-directed 401k allows for expanded investment choices.

Evaluating Brokerage Account Providers

Evaluating and choosing the best brokerage account provider will depend upon the types of investments and the level of service the investor is seeking. Whereas a do-it-yourself investor who wants to keep costs low might choose a discount broker; an investor needing investment advice and assistance with trading may consider a full-service broker.

Here are the basics considerations in evaluating discount brokers versus full serve brokers:

  • Discount broker: Low costs, best for investors who do not need investment advice or assistance with trades. Stocks and ETFs generally trade commission-free. Some mutual funds may have transaction fees.
  • Full-service broker: Higher costs than discount brokers, best for investors who need investment advice, portfolio management, and/or assistance with trades.

How To Open a Brokerage Account

To open a brokerage account, new account owners will be required to provide personal information. When opening a brokerage account the new account owner will typically have the option of a cash account or a margin account.

  • Cash account: Standard brokerage accounts are typically cash accounts, which means they are funded with cash that is transferred to the brokerage. To do this, the investor may link their bank account to the brokerage account, mail a check, or wire funds. The account holder then uses the cash funds to buy investment securities.
  • Margin account: Investors will use a margin account if they want to borrow funds from the brokerage firm to purchase securities. This is called buying securities "on margin." Some investors use margin accounts for the purpose of short-selling a stock, which is not possible within cash accounts.

Tip: Brokerage accounts are commonly opened online and it can take less than 20 minutes for an investor to submit an application. Depending upon the brokerage, the account number and online access may be provided to the new account holder within 48 hours of submitting the application.

Bottom Line

A brokerage account is a taxable investment account that investors can open at a brokerage firm. Brokerage accounts can be used to transact in a variety of investment securities, and can be used by investors as an alternative or a supplement to retirement accounts like IRAs and 401ks. Distinguishing features of brokerage accounts include broad investment selection, low costs, and taxation of capital gains and dividends.

This article was written by

Kent Thune profile picture
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Kent Thune, CFP®, is a fiduciary investment advisor specializing in tactical asset allocation and portfolio management with a focus on ETFs and sector investing. Mr. Thune has 25 years of wealth management experience and has navigated clients through four bear markets and some of the most challenging economic environments in history. As a writer, Kent's articles have been seen on multiple investing and finance websites, including Seeking Alpha, Kiplinger, MarketWatch, The Motley Fool, Yahoo Finance, and The Balance. Mr. Thune's registered investment advisory firm is headquartered in Hilton Head Island, SC where he serves clients all around the United States. When not writing or advising clients, Kent spends time with his wife and two sons, plays guitar, or works on his philosophy book that he plans to publish later in 2022.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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