You’ve fully met your employer’s matching funds in the company 401(k) and have a robust emergency fund—good job. The next step in your financial journey may be to open a brokerage investment account to make the most of your available investing funds. Brokerage accounts can be a great option to round out your investment portfolio and help you grow your money faster than a traditional savings account, but there are some drawbacks to be aware of.
Tune in to this week’s episode of the rich & REGULAR podcast, and keep reading below to learn more about these investment accounts.
What is a brokerage account?
Simply put, brokerage accounts are a way to purchase stocks, bonds, or other investment vehicles like exchange-traded funds and access them in one place. They function similarly to a retirement account, like a 401(k) or Roth IRA, but instead of being tax-advantaged, as the retirement accounts are, brokerage accounts are taxed as income under capital gains.
This means there is no tax benefit to using these accounts, but there are also no fees or penalties for early withdrawals, and you can access the money whenever you want. Be aware that these accounts do come with various fees, including when you buy, sell or trade stocks, so make sure you understand the ins and outs so you aren’t hit with a heavy brokerage fee after a transaction.
Brokerage accounts are a great addition to a diverse portfolio along with your retirement accounts and emergency fund, but they should not be used in place of these other accounts. Make sure you’re discussing your personal situation with a financial adviser so you can make the best decisions for yourself.
Can’t I just use a savings account?
Although it is important to have a robust emergency fund easily and quickly accessible in a traditional or online savings account, savings accounts don’t give your money the potential to grow the way a brokerage account can. Savings accounts currently offer fractions of pennies on the dollar, with many of them presently offering around .55% (or .0055) in interest (as of July 19, 2021).
On the other hand, the stock market might return up to 10% a year, based on the current state of the market and the individual stocks (or mutual funds) you are invested in. That is obviously a much better rate of return on investment. Brokerage accounts also keep your funds fairly liquid and available, like a savings account. But it can take a couple of days for trades to go through and withdrawals to be deposited in your primary checking account. So it can be beneficial to use them in conjunction with a traditional savings account.
How do I open a brokerage account?
Brokerage accounts are pretty easy to open and can be created online in a few easy steps. The brokerage website will ask some general questions such as:
- Your full name
- Date of birth
- Social Security number
- Your employment and tax filing status
- Other investment accounts or assets you have
- Your risk tolerance
- How long you plan to invest your funds
That might seem like a lot of personal information above and beyond basic banking, but investment firms are required to collect certain types of data to help prevent identity theft and help you find suitable investments.
Do your research.
There are a variety of investment brokers out there, and each offers something slightly different. Companies like Vanguard and Charles Schwab can be great for beginning investors because they have extensive FAQ and help sections on their websites, as well as the option to speak with an investment adviser if you need assistance. Newer brokerage firms may have fewer fees or a gamified interface that appeals to you but with less help available if you have questions.
It’s important to consider the following when researching brokerage accounts:
What type of investor are you? If you’re someone who checks on the market daily, you may want an account that gives you more fine-tuning control. If you’re going to be more hands-off and leave your deposits to grow over time, you might want a firm that uses a robot or financial adviser to keep an eye on things and rebalance as needed.
What is your risk tolerance? Generally, younger people can tolerate more risk in the stock market because they have more time for the market to correct itself after a drop. If your investing timeline is shorter, or you don’t have the cash to potentially lose, such as investing money for a child’s college education or a down payment on a house, it makes sense to take a more conservative approach. Gauge your risk tolerance carefully—it is easy to go after big rewards when the market is doing well, but it can be harder to live with the consequences during a market correction or slump.
Consider the features and fees. Brokerage accounts can have various features based on what their clients need. Some are geared more toward robo-investing and offer online support and information. Other brokerages offer more of a concierge-type service, with real people providing advice and helping you make decisions.
Decide on what makes you most comfortable, but remember that more services generally come with more fees. Be sure you understand the fee structure, any investment minimums or other requirements before creating an account. Knowing the details upfront can save you a lot of headaches later on.
Always do your homework.
Brokerage Accounts offer many benefits, especially when part of a well-diversified portfolio containing tax-advantaged retirement accounts, emergency funds and other investment opportunities. It’s important to remember that even though the potential for big rewards exists with brokerage accounts, you are still investing money in the stock market, and as we have seen many times, what goes up will also come down. Do your research to find the brokerage firm that meets your needs, and then make sure you understand the fees, minimums and other account parameters to ensure you’re growing your money as effectively as possible.