Why Would You Open a Brokerage Account?

Money sitting in a checking account earns little or nothing. Inflation, which is the gradual rise in prices over time, steadily shrinks what that money can buy.

A brokerage account gives you access to investments that have historically grown faster than inflation over long periods, which is how many people build wealth beyond their paycheck.

Since its launch in 1957, the S&P 500 index, which tracks the stocks of 500 of the biggest publicly traded companies in the United States, has returned an average of about 10% a year, according to Fidelity Investments. 

The danger is that your investments can also fall in value, sometimes to nothing. A good rule of thumb is that you should never invest more than you can afford to lose.

How Does a Brokerage Account Work?

After you open the account, you link your bank account and transfer money in, which typically takes one to three business days to arrive.

To buy an investment, you look up its name or ticker symbol, which is a shorthand code such as NKE for Nike, along with how much you want to buy. The broker then executes the trade.

After the trade clears, the investment stays in your account, where it can rise or fall in value. It may also pay dividends, which are cash payments some companies share with their stockholders.

If you decide to sell your investment, the proceeds return to your account as cash. You can reinvest the money or transfer it back to your bank, usually within one or two days of the sale. If you make money on your investment, it’s taxable.

What Can You Buy in a Brokerage Account?

Most brokerage accounts offer the same core menu of investments, even if the exact selection varies by firm.

Stocks

A stock is a small slice of ownership in a single company, so its value rises and falls with how that business performs.

Exchange-Traded Funds

An exchange-traded fund is a basket of many investments bundled into one product, such as an ETF holding all 500 companies in the S&P 500. It trades throughout the day like a single stock.

Mutual Funds

A mutual fund also pools many investments together, but it’s priced and traded once per day after the market closes, rather than throughout the day.

Bonds

A bond is a loan you make to a government or company in exchange for regular interest payments and the return of your money on a set date.

How Are Brokerage Accounts Taxed?

In a regular taxable account, you owe tax on capital gains, which are the profits you make when you sell an investment for more than you paid.

If you buy $1,000 of stock and later sell it for $1,500, your capital gain is $500, and that $500 is what gets taxed, not the full $1,500.

How long you hold an investment matters. If you’re selling it less than a year after you bought it, it’s treated as a short-term capital gain. It’s taxed as ordinary income, which means that your profit is added on to your regular income on your tax return.

If you sell an investment after a year, it’s treated as a long-term capital gain, which can run from 0% to 20% depending on your income and tax-filing status.

An investment that simply rises in value inside your account does not trigger a tax bill on its own, so you pay nothing until you actually sell.

Is Your Money Safe in a Brokerage Account?

Brokerage accounts at member firms are protected by the Securities Investor Protection Corporation, or SIPC, a nonprofit created by the U.S. government.

SIPC protects up to $500,000 per account, including up to $250,000 in cash, if your brokerage firm fails and your investments go missing.

It’s important to note that SIPC does not cover a drop in the value of the investments you’ve made. If you buy $5,000 in stock and it falls to $3,000, that $2,000 loss is yours.

Do You Need a Lot of Money to Start?

It’s easy to assume that investing requires thousands of dollars, but most major online brokers now have no account minimum.

Many also offer fractional shares, which let you buy a portion of a single share, so you can put $10 into a stock that trades at $200 and own one-twentieth of a share.

What Does a Brokerage Account Cost?

Most large online brokers now charge zero commission, meaning no fee per trade, when you buy or sell U.S. stocks and ETFs. There may be other costs, though, that can eat into your returns.

Fund Expense Ratios

An expense ratio is the yearly fee a mutual fund or ETF charges to cover operating costs. It’s shown as a percentage of your investment, so a 0.03% ratio costs $3 a year for every $10,000 invested. Expense ratios can vary widely, and some funds don’t charge them.

Account Transfer Fees

Many brokers charge a fee, often around $75, if you move your whole account to a different firm, but some brokers will reimburse the fee for new customers.

Margin Interest

A margin account lets you borrow money from the broker to invest. It charges interest and can multiply your losses, so beginner investors may want to stick with a standard cash account that only invests the money you deposit.

How to Open a Brokerage Account

Opening an account online typically takes 10 to 15 minutes.You’ll need your Social Security number, a government-issued ID, your employment information, and the routing and account numbers for the bank account you plan to fund it from.

Once your information is verified and you’ve deposited money into your account, you can start making trades.

Before you sign up, you can look up any firm on FINRA BrokerCheck. It’s a free tool from the industry's regulator that shows whether a broker is registered and lists any past disciplinary actions.