Looking for a way to invest money for retirement, college or a shorter term goal like buying a house or starting a business? Assuming you’re already contributing at least what your company matches in its retirement plan (if there’s one available) and that you have an adequate emergency fund, you may want to open a brokerage account. It offers an option besides a 401(k) to invest in the market.
Through a brokerage account, you can buy and sell stocks, bonds, mutual funds, exchange-traded funds and other types of investments — in some cases without having to pay taxes on the growth. Although you open a brokerage account through a broker, you can make the investing decisions yourself. Depending on the broker and type of account you choose, the commission (or fee) you pay can be as low as $5-$10 per trade. Here’s what you should know before you open an account.
There are basically two different types of brokers: traditional and discount. Traditional brokers — like Morgan Stanley, Merrill Lynch and Wells Fargo Advisors — specialize in providing personalized investment advice and typically offer a wide range of financial services for a premium.
Discount brokers — like Fidelity, Schwab and ETrade — specialize in offering DIY, low-cost investing services and education. Most discount brokers have representatives available for occasional questions, and some have professional account management available for an additional fee, but the point is to save money by making your own investment decisions. Lately, more traditional brokers are offering self-directed platforms as well to stay competitive.
What You Need to Get Started
When you open a new account, you will need to invest a minimum amount of money — typically more for a taxable account and less for an IRA or 529 college savings account — but the amount varies depending on the broker. Traditional brokers generally require a higher minimum than discount brokers who sometimes even waive their minimum requirement if you set up automatic contributions. TD Ameritrade is one discount broker that does not currently have a minimum deposit requirement. Traditional brokers typically charge an annual account fee (but waive it in certain situations), while discount brokers typically do not. With any broker, keep an eye out for other fees that may be hidden in fine print.
The process of opening an account is generally easy and quick. Traditional brokers typically require that you open an account through an advisor who can build a relationship with you and provide you with (and get paid for) additional services as needed. Opening an account through a discount broker can usually be done online, or you can print out the application and mail it along with a check for the initial deposit.
Keep reading for more on taxes and investing options.
Who’s Managing My Money?
Opening a brokerage account does not mean that your money is automatically invested (unless you have arranged for a transfer of investments you already own from one account to another). If you’re not paying extra to have a professional trade for you, YOU are responsible for buying and selling the investments in your account. When you make deposits, the broker will typically park them in a money market fund where they will earn minimal interest until you buy other securities.
You can set up an account that’s professionally invested, though it’ll cost you more. A “discretionary,” or advisory, brokerage account is managed by a financial professional who has the authority to make investment decisions at will on your behalf. These types of accounts are more common with traditional brokers than discount brokers, and require a substantial amount to open — usually a $25,000 or $50,000 minimum investment. They also charge a commission per trade and/or an annual fee. If it is a fee-based, or “wrap,” account, you will likely be charged between 1-2 percent of your account value per year to cover administrative, custodial, research and trading costs. That doesn’t cover additional expenses potentially charged by the mutual or exchange-traded funds you might own in your account.
What About Taxes?
It is important to understand that a brokerage account is a taxable account unless it is an Individual Retirement Account (IRA) or 529 college savings account, in which case you benefit from tax deferral (or tax exemption in the case of Roth IRAs, assuming certain requirements are met). This means that you can owe annual taxes on your investments, especially if you sell securities that have grown in value. So you should keep track of what you originally paid for each security in your account (aka “cost basis”) and understand what the capital loss or gain might be before selling.
How Do I Set Up Contributions?
The best way to fund a brokerage account and grow your money is to set up automatic monthly transfers from a savings or checking account, which you can usually do online or by calling or visiting your bank. You might also be able to set up automatic investing of your deposits in certain mutual funds. It’s worth the effort to set these up. Taking these steps will you force yourself to save your money rather than spend it and allow you to take advantage of monthly compounding that can significantly boost your return over the long term.
Bottom Line: Whether you are committed to saving money through DIY investing or you’re willing to pay extra for professional help, make sure you do thorough research and understand all potential costs, requirements and restrictions before opening any brokerage account.